Money Out of Nowhere: How Internet Marketplaces Unlock Economic Wealth


This post is by bgurley from Above the Crowd

(*) Benchmark is/was an investor in companies labeled with the asterisk.

In 1776, Adam Smith released his magnum opus, An Inquiry into the Nature and Causes of the Wealth of Nations, in which he outlined his fundamental economic theories. Front and center in the book — in fact in Book 1, Chapter 1 — is his realization of the productivity improvements made possible through the “Division of Labour”:

It is the great multiplication of the production of all the different arts, in consequence of the division of labour, which occasions, in a well-governed society, that universal opulence which extends itself to the lowest ranks of the people. Every workman has a great quantity of his own work to dispose of beyond what he himself has occasion for; and every other workman being exactly in the same situation, he is enabled to exchange a great quantity of his own goods for a great quantity, or, what comes to the same thing, for the price of a great quantity of theirs. He supplies them abundantly with what they have occasion for, and they accommodate him as amply with what he has occasion for, and a general plenty diffuses itself through all the different ranks of society.

Smith identified that when men and women specialize their skills, and also importantly “trade” with one another, the end result is a rise in productivity and standard of living for everyone. In 1817, David Ricardo published On the Principles of Political Economy and Taxation where he expanded upon Smith’s work in developing the theory of Comparative Advantage. What Ricardo proved mathematically, is that if one country has simply a comparative advantage (not even an absolute one), it still is in everyone’s best interest to embrace specialization and free trade. In the end, everyone ends up in a better place.

There are two key requirements for these mechanisms to take force. First and foremost, you need free and open trade. It is quite bizarre to see modern day politicians throw caution to the wind and ignore these fundamental tenants of economic science. Time and time again, the fact patterns show that when countries open borders and freely trade, the end result is increased economic prosperity. The second, and less discussed, requirement is for the two parties that should trade to be aware of one another’s goods or services. Unfortunately, either information asymmetry or physical distances and the resulting distribution costs can both cut against the economic advantages that would otherwise arise for all.

Fortunately, the rise of the Internet, and specifically Internet marketplace models, act as accelerants to the productivity benefits of the division of labour AND comparative advantage by reducing information asymmetry and increasing the likelihood of a perfect match with regard to the exchange of goods or services. In his 2005 book, The World Is Flat, Thomas Friedman recognizes that the Internet has the ability to create a “level playing field” for all participants, and one where geographic distances become less relevant. The core reason that Internet marketplaces are so powerful is because in connecting economic traders that would otherwise not be connected, they unlock economic wealth that otherwise would not exist. In other words, they literally create “money out of nowhere.”

Exchange of Goods Marketplaces

Any discussion of Internet marketplaces begins with the first quintessential marketplace, ebay(*). Pierre Omidyar founded AuctionWeb in September of 1995, and its rise to fame is legendary. What started as a web site to trade laser pointers and Beanie Babies (the Pez dispenser start is quite literally a legend), today enables transactions of approximately $100B per year. Over its twenty-plus year lifetime, just over one trillion dollars in goods have traded hands across eBay’s servers. These transactions, and the profits realized by the sellers, were truly “unlocked” by eBay’s matching and auction services.

In 1999, Jack Ma created Alibaba, a Chinese-based B2B marketplace for connecting small and medium enterprise with potential export opportunities. Four years later, in May of 2003, they launched Taobao Marketplace, Alibaba’s answer to eBay. By aggressively launching a free to use service, Alibaba’s Taobao quickly became the leading person-to-person trading site in China. In 2018, Taobao GMV (Gross Merchandise Value) was a staggering RMB2,689 billion, which equates to $428 billion in US dollars.

There have been many other successful goods marketplaces that have launched post eBay & Taobao — all providing a similar service of matching those who own or produce goods with a distributed set of buyers who are particularly interested in what they have to offer. In many cases, a deeper focus on a particular category or vertical allows these marketplaces to distinguish themselves from broader marketplaces like eBay.

  • In 2000, Eric Baker and Jeff Fluhr founded StubHub, a secondary ticket exchange marketplace. The company was acquired by ebay in January 2007. In its most recent quarter, StubHub’s GMV reached $1.4B, and for the entire year 2018, StubHub had GMV of $4.8B.
  • Launched in 2005, Etsy is a leading marketplaces for the exchange of vintage and handmade items. In its most recent quarter, the company processed the exchange of $923 million of sales, which equates to a $3.6B annual GMV.
  • Founded by Michael Bruno in Paris in 2001, 1stdibs(*) is the world’s largest online marketplace for luxury one-of-a-kind antiques, high-end modern furniture, vintage fashion, jewelry, and fine art. In November 2011, David Rosenblatt took over as CEO and has been scaling the company ever since. Over the past few years dealers, galleries, and makers have matched billions of dollars in merchandise to trade buyers and consumer buyers on the platform.
  • Poshmark was founded by Manish Chandra in 2011. The website, which is an exchange for new and used clothing, has been remarkably successful. Over 4 million sellers have earned over $1 billion transacting on the site.
  • Julie Wainwright founded The Real Real in 2011. The company is an online marketplace for authenticated luxury consignment. In 2017, the company reported sales of over $500 million.
  • In 2015, Eddy Lu and Daishin Sugano launched GOAT, a marketplace for the exchange of sneakers. Despite this narrow focus, the company has been remarkably successful. The estimated annual GMV of GOAT and its leading competitor Stock X is already over $1B per year (on a combined basis).

SHARING ECONOMY MARKETPLACES

With the launch of Airbnb in 2008 and Uber (*) in 2009, these two companies established a new category of marketplaces known as the “sharing economy.” Homes and automobiles are the two most expensive items that people own, and in many cases the ability to own the asset is made possible through debt — mortgages on houses and car loans or leases for automobiles. Despite this financial exposure, for many people these assets are materially underutilized. Many extra rooms and second homes are vacant most of the year, and the average car is used less than 5% of the time. Sharing economy marketplaces allow owners to “unlock” earning opportunities from these underutilized assets.

Airbnb was founded by Joe Gebbia and Brian Chesky in 2008. Today there are over 5 million Airbnb listings in 81,000 cities. Over two million people stay in an Airbnb each night. In November of this year, the company announced that it had achieved “substantially” more than $1B in revenue in the third quarter. Assuming a marketplace rake of something like 11%, this would imply gross room revenue of over $9B for the quarter — which would be $36B annualized. As the company is still growing, we can easily guess that in 2019-2020 time frame, Airbnb will be delivering around $50B per year to home-owners who were previously sitting on highly underutilized assets. This is a major “unlocking.”

When Garrett Camp and Travis Kalanick founded Uber in 2009, they hatched the industry now known as ride-sharing. Today over 3 million people around the world use their time and their underutilized automobiles to generate extra income. Without the proper technology to match people who wanted a ride with people who could provide that service, taxi and chauffeur companies were drastically underserving the potential market. As an example, we estimate that ride-sharing revenues in San Francisco are well north of 10X what taxis and black cars were providing prior to the launch of ride-sharing. These numbers will go even higher as people increasingly forgo the notion of car ownership altogether. We estimate that the global GMV for ride sharing was over $100B in 2018 (including Uber, Didi, Grab, Lyft, Yandex, etc) and still growing handsomely. Assuming a 20% rake, this equates to over $80B that went into the hands of ride-sharing drivers in a single year — and this is an industry that did not exist 10 years ago. The matching made possible with today’s GPS and Internet-enabled smart phones is a massive unlocking of wealth and value.

While it is a lesser known category, using your own backyard and home to host dog guests as an alternative to a kennel is a large and growing business. Once again, this is an asset against which the marginal cost to host a dog is near zero. By combining their time with this otherwise unused asset, dog sitters are able to offer a service that is quite compelling for consumers. Rover.com (*) in Seattle, which was founded by Greg Gottesman and Aaron Easterly in 2011, is the leading player in this market. (Benchmark is an investor in Rover through a merger with DogVacay in 2017). You may be surprised to learn that this is already a massive industry. In less than a decade since the company started, Rover has already paid out of half a billion dollars to hosts that participate on the platform.

Exchange of LABOR Marketplaces

While not as well known as the goods exchanges or sharing economy marketplaces, there is a growing and exciting increase in the number of marketplaces that help match specifically skilled labor with key opportunities to monetize their skills. The most noteworthy of these is likely Upwork(*), a company that formed from the merger of Elance and Odesk. Upwork is a global freelancing platform where businesses and independent professionals can connect and collaborate remotely. Popular categories include web developers, mobile developers, designers, writers, and accountants. In the 12 months ended June 30, 2018, the Upwork platform enabled $1.56 billion of GSV (gross services revenue) across 2.0 million projects between approximately 375,000 freelancers and 475,000 clients in over 180 countries. These labor matches represent the exact “world is flat” reality outlined in Friedman’s book.

Other noteworthy and emerging labor marketplaces:

  • HackerOne(*) is the leading global marketplace that coordinates the world’s largest corporate “bug bounty” programs with a network of the world’s leading hackers. The company was founded in 2012 by Michiel Prins, Jobert Abma, Alex Rice and Merijn Terheggen, and today serves the needs of over 1,000 corporate bug bounty programs. On top of that, the HackerOne network of over 300,000 hackers (adding 600 more each day) has resolved over 100K confirmed vulnerabilities which resulted in over $46 million in awards to these individuals. There is an obvious network effect at work when you bring together the world’s leading programs and the world’s leading hackers on a single platform. The Fortune 500 is quickly learning that having a bug bounty program is an essential step in fighting cyber crime, and that HackerOne is the best place to host their program.
  • Wyzant is a leading Chicago-based marketplace that connects tutors with students around the country. The company was founded by Andrew Geant and Mike Weishuhn in 2005. The company has over 80,000 tutors on its platform and has paid out over $300 million to these professionals. The company started matching students with tutors for in-person sessions, but increasingly these are done “virtually” over the Internet.
  • Stitch Fix (*) is a leading provider of personalized clothing services that was founded by Katrina Lake in 2011. While the company is not primarily a marketplace, each order is hand-curated by a work-at-home “stylist” who works part-time on their own schedule from the comfort of their own home. Stitch Fix’s algorithms match the perfect stylist with each and every customer to help ensure the optimal outcome for each client. As of the end of 2018, Stitch Fix has paid out well over $100 million to their stylists.
  • Swing Education was founded in 2015 with the objective of creating a marketplace for substitute teachers. While it is still early in the company’s journey, they have already established themselves as the leader in the U.S. market. Swing is now at over 1,200 school partners and has filled over 115,000 teacher absence days. They have helped 2,000 substitute teachers get in the classroom in 2018, including 400 educators who earned permits, which Swing willingly financed. While it seems obvious in retrospect, having all substitutes on a single platform creates massive efficiency in a market where previously every single school had to keep their own list and make last minute calls when they had vacancies. And their subs just have to deal with one Swing setup process to get access to subbing opportunities at dozens of local schools and districts.
  • RigUp was founded by Xuan Yong and Mike Witte in Austin, Texas in March of 2014. RigUp is a leading labor marketplace focused on the oilfield services industry. “The company’s platform offers a large network of qualified, insured and compliant contractors and service providers across all upstream, midstream and downstream operations in every oil and gas basin, enabling companies to hire quickly, track contractor compliance, and minimize administrative work.” According to the company, GMV for 2017 was an impressive $150 million, followed by an astounding $600 million in 2018. Often, investors miss out on vertically focused companies like RigUp as they find themselves overly anxious about TAM (total available market). As you can see, that can be a big mistake.
  • VIPKid, which was founded in 2013 by Cindy Mi, is a truly amazing story. The idea is simple and simultaneously brilliant. VIPKid links students in China who want to learn English with native English speaking tutors in the United States and Canada. All sessions are done over the Internet, once again epitomizing Friedman’s very flat world. In November of 2018, the company reported having 60,000 teachers contracted to teach over 500,000 students. Many people believe the company is now well north of a US$1B run rate, which implies that around $1B will pass hands from Chinese parents to western teachers in 2019. That is quite a bit of supplemental income for U.S.-based teachers.

These vertical labor marketplaces are to LinkedIn what companies like Zillow, Expedia, and GrubHub are to Google search. Through a deeper understanding of a particular vertical, a much richer perspective on the quality and differentiation of the participants, and the enablement of transactions — you create an evolved service that has much more value to both sides of the transaction. And for those professionals participating in these markets, your reputation on the vertical service matters way more than your profile on LinkedIn.

NEW EMERGING MARKETPLACES

Having been a fortunate investor in many of the previously mentioned companies (*), Benchmark remains extremely excited about future marketplace opportunities that will unlock wealth on the Internet. Here are an example of two such companies that we have funded in the past few years.

The New York Times describes Hipcamp as “The Sharing Economy Visits the Backcountry.” Hipcamp(*) was founded in 2013 by Alyssa Ravasio as an engine to search across the dozens and dozens of State and National park websites for campsite availability. As Hipcamp gained traction with campers, landowners with land near many of the National and State parks started to reach out to Hipcamp asking if they could list their land on Hipcamp too. Hipcamp now offers access to more than 350k campsites across public and private land, and their most active private land hosts make over $100,000 per year hosting campers. This is a pretty amazing value proposition for both land owners and campers. If you are a rural landowner, here is a way to create “money out of nowhere” with very little capital expenditures. And if you are a camper, what could be better than to camp at a unique, bespoke campsite in your favorite location.

Instawork(*) is an on-demand staffing app for gig workers (professionals) and hospitality businesses (partners). These working professionals seek economic freedom and a better life, and Instawork gives them both — an opportunity to work as much as they like, but on their own terms with regard to when and where. On the business partner side, small business owners/managers/chefs do not have access to reliable sources to help them with talent sourcing and high turnover, and products like  LinkedIn are more focused on white-collar workers. Instawork was cofounded by Sumir Meghani in San Franciso and was a member of the 2015 Y-Combinator class. 2018 was a break-out year for Instawork with 10X revenue growth and 12X growth in Professionals on the platform. The average Instawork Professional is highly engaged on the platform, and typically opens the Instawork app ten times a day. This results in 97% of gigs being matched in less than 24 hours — which is powerfully important to both sides of the network. Also noteworthy, the Professionals on Instawork average 150% of minimum wage, significantly higher than many other labor marketplaces. This higher income allows Instawork Professionals like Jose, to begin to accomplish their dreams.

The Power of These Platforms

As you can see, these numerous marketplaces are a direct extension of the productivity enhancers first uncovered by Adam Smith and David Ricardo. Free trade, specialization, and comparative advantage are all enhanced when we can increase the matching of supply and demand of goods and services as well as eliminate inefficiency and waste caused by misinformation or distance. As a result, productivity naturally improves.

Specific benefits of global internet marketplaces:

    1. Increase wealth distribution (all examples)
    2. Unlock wasted potential of assets (Uber, AirBNB, Rover, and Hipcamp)
    3. Better match of specific workers with specific opportunities (Upwork, WyzAnt, RigUp, VIPKid, Instawork)
    4. Make specific assets reachable and findable (Ebay, Etsy, 1stDibs, Poshmark, GOAT)
    5. Allow for increased specialization (Etsy, Upwork, RigUp)
    6. Enhance supplemental labor opportunities (Uber, Stitch Fix, SwingEducation, Instawork, VIPKid), where the worker is in control of when and where they work
    7. Reduces forfeiture by enhancing utilization (mortgages, car loans, etc) (Uber, AirBnb, Rover, Hipcamp)

If you are a founder who is excited about starting a new marketplace, there are two caveats that are important to remember. First, you will need to find industries where the opportunity to improve the efficiency in the ways noted above is evident. If the network does not create true economic leverage, you will find it hard to be successful. Second, for any marketplace to be successful, the conditions in that given market must be optimal for a new marketplace entrant. Please check out our previous post, All Markets Are Not Created Equal: 10 Factors To Consider When Evaluating Digital Marketplaces, for a list of factors that help distinguish a great opportunity. If after taking in these considerations you think you have found such an opportunity, we would love to talk to you about potentially partnering together. Please send us an email to unlockingwealth@benchmark.com.

(*) Benchmark either is or was an investor in companies labeled with the asterisk.

Interested in “Unlocking Wealth” Yourself?

Money Out of Nowhere: How Internet Marketplaces Unlock Economic Wealth


This post is by bgurley from Above the Crowd

(*) Benchmark is/was an investor in companies labeled with the asterisk.

In 1776, Adam Smith released his magnum opus, An Inquiry into the Nature and Causes of the Wealth of Nations, in which he outlined his fundamental economic theories. Front and center in the book — in fact in Book 1, Chapter 1 — is his realization of the productivity improvements made possible through the “Division of Labour”:

It is the great multiplication of the production of all the different arts, in consequence of the division of labour, which occasions, in a well-governed society, that universal opulence which extends itself to the lowest ranks of the people. Every workman has a great quantity of his own work to dispose of beyond what he himself has occasion for; and every other workman being exactly in the same situation, he is enabled to exchange a great quantity of his own goods for a great quantity, or, what comes to the same thing, for the price of a great quantity of theirs. He supplies them abundantly with what they have occasion for, and they accommodate him as amply with what he has occasion for, and a general plenty diffuses itself through all the different ranks of society.

Smith identified that when men and women specialize their skills, and also importantly “trade” with one another, the end result is a rise in productivity and standard of living for everyone. In 1817, David Ricardo published On the Principles of Political Economy and Taxation where he expanded upon Smith’s work in developing the theory of Comparative Advantage. What Ricardo proved mathematically, is that if one country has simply a comparative advantage (not even an absolute one), it still is in everyone’s best interest to embrace specialization and free trade. In the end, everyone ends up in a better place.

There are two key requirements for these mechanisms to take force. First and foremost, you need free and open trade. It is quite bizarre to see modern day politicians throw caution to the wind and ignore these fundamental tenants of economic science. Time and time again, the fact patterns show that when countries open borders and freely trade, the end result is increased economic prosperity. The second, and less discussed, requirement is for the two parties that should trade to be aware of one another’s goods or services. Unfortunately, either information asymmetry or physical distances and the resulting distribution costs can both cut against the economic advantages that would otherwise arise for all.

Fortunately, the rise of the Internet, and specifically Internet marketplace models, act as accelerants to the productivity benefits of the division of labour AND comparative advantage by reducing information asymmetry and increasing the likelihood of a perfect match with regard to the exchange of goods or services. In his 2005 book, The World Is Flat, Thomas Friedman recognizes that the Internet has the ability to create a “level playing field” for all participants, and one where geographic distances become less relevant. The core reason that Internet marketplaces are so powerful is because in connecting economic traders that would otherwise not be connected, they unlock economic wealth that otherwise would not exist. In other words, they literally create “money out of nowhere.”

Exchange of Goods Marketplaces

Any discussion of Internet marketplaces begins with the first quintessential marketplace, ebay(*). Pierre Omidyar founded AuctionWeb in September of 1995, and its rise to fame is legendary. What started as a web site to trade laser pointers and Beanie Babies (the Pez dispenser start is quite literally a legend), today enables transactions of approximately $100B per year. Over its twenty-plus year lifetime, just over one trillion dollars in goods have traded hands across eBay’s servers. These transactions, and the profits realized by the sellers, were truly “unlocked” by eBay’s matching and auction services.

In 1999, Jack Ma created Alibaba, a Chinese-based B2B marketplace for connecting small and medium enterprise with potential export opportunities. Four years later, in May of 2003, they launched Taobao Marketplace, Alibaba’s answer to eBay. By aggressively launching a free to use service, Alibaba’s Taobao quickly became the leading person-to-person trading site in China. In 2018, Taobao GMV (Gross Merchandise Value) was a staggering RMB2,689 billion, which equates to $428 billion in US dollars.

There have been many other successful goods marketplaces that have launched post eBay & Taobao — all providing a similar service of matching those who own or produce goods with a distributed set of buyers who are particularly interested in what they have to offer. In many cases, a deeper focus on a particular category or vertical allows these marketplaces to distinguish themselves from broader marketplaces like eBay.

  • In 2000, Eric Baker and Jeff Fluhr founded StubHub, a secondary ticket exchange marketplace. The company was acquired by ebay in January 2007. In its most recent quarter, StubHub’s GMV reached $1.4B, and for the entire year 2018, StubHub had GMV of $4.8B.
  • Launched in 2005, Etsy is a leading marketplaces for the exchange of vintage and handmade items. In its most recent quarter, the company processed the exchange of $923 million of sales, which equates to a $3.6B annual GMV.
  • Founded by Michael Bruno in Paris in 2001, 1stdibs(*) is the world’s largest online marketplace for luxury one-of-a-kind antiques, high-end modern furniture, vintage fashion, jewelry, and fine art. In November 2011, David Rosenblatt took over as CEO and has been scaling the company ever since. Over the past few years dealers, galleries, and makers have matched billions of dollars in merchandise to trade buyers and consumer buyers on the platform.
  • Poshmark was founded by Manish Chandra in 2011. The website, which is an exchange for new and used clothing, has been remarkably successful. Over 4 million sellers have earned over $1 billion transacting on the site.
  • Julie Wainwright founded The Real Real in 2011. The company is an online marketplace for authenticated luxury consignment. In 2017, the company reported sales of over $500 million.
  • In 2015, Eddy Lu and Daishin Sugano launched GOAT, a marketplace for the exchange of sneakers. Despite this narrow focus, the company has been remarkably successful. The estimated annual GMV of GOAT and its leading competitor Stock X is already over $1B per year (on a combined basis).

SHARING ECONOMY MARKETPLACES

With the launch of Airbnb in 2008 and Uber (*) in 2009, these two companies established a new category of marketplaces known as the “sharing economy.” Homes and automobiles are the two most expensive items that people own, and in many cases the ability to own the asset is made possible through debt — mortgages on houses and car loans or leases for automobiles. Despite this financial exposure, for many people these assets are materially underutilized. Many extra rooms and second homes are vacant most of the year, and the average car is used less than 5% of the time. Sharing economy marketplaces allow owners to “unlock” earning opportunities from these underutilized assets.

Airbnb was founded by Joe Gebbia and Brian Chesky in 2008. Today there are over 5 million Airbnb listings in 81,000 cities. Over two million people stay in an Airbnb each night. In November of this year, the company announced that it had achieved “substantially” more than $1B in revenue in the third quarter. Assuming a marketplace rake of something like 11%, this would imply gross room revenue of over $9B for the quarter — which would be $36B annualized. As the company is still growing, we can easily guess that in 2019-2020 time frame, Airbnb will be delivering around $50B per year to home-owners who were previously sitting on highly underutilized assets. This is a major “unlocking.”

When Garrett Camp and Travis Kalanick founded Uber in 2009, they hatched the industry now known as ride-sharing. Today over 3 million people around the world use their time and their underutilized automobiles to generate extra income. Without the proper technology to match people who wanted a ride with people who could provide that service, taxi and chauffeur companies were drastically underserving the potential market. As an example, we estimate that ride-sharing revenues in San Francisco are well north of 10X what taxis and black cars were providing prior to the launch of ride-sharing. These numbers will go even higher as people increasingly forgo the notion of car ownership altogether. We estimate that the global GMV for ride sharing was over $100B in 2018 (including Uber, Didi, Grab, Lyft, Yandex, etc) and still growing handsomely. Assuming a 20% rake, this equates to over $80B that went into the hands of ride-sharing drivers in a single year — and this is an industry that did not exist 10 years ago. The matching made possible with today’s GPS and Internet-enabled smart phones is a massive unlocking of wealth and value.

While it is a lesser known category, using your own backyard and home to host dog guests as an alternative to a kennel is a large and growing business. Once again, this is an asset against which the marginal cost to host a dog is near zero. By combining their time with this otherwise unused asset, dog sitters are able to offer a service that is quite compelling for consumers. Rover.com (*) in Seattle, which was founded by Greg Gottesman and Aaron Easterly in 2011, is the leading player in this market. (Benchmark is an investor in Rover through a merger with DogVacay in 2017). You may be surprised to learn that this is already a massive industry. In less than a decade since the company started, Rover has already paid out of half a billion dollars to hosts that participate on the platform.

Exchange of LABOR Marketplaces

While not as well known as the goods exchanges or sharing economy marketplaces, there is a growing and exciting increase in the number of marketplaces that help match specifically skilled labor with key opportunities to monetize their skills. The most noteworthy of these is likely Upwork(*), a company that formed from the merger of Elance and Odesk. Upwork is a global freelancing platform where businesses and independent professionals can connect and collaborate remotely. Popular categories include web developers, mobile developers, designers, writers, and accountants. In the 12 months ended June 30, 2018, the Upwork platform enabled $1.56 billion of GSV (gross services revenue) across 2.0 million projects between approximately 375,000 freelancers and 475,000 clients in over 180 countries. These labor matches represent the exact “world is flat” reality outlined in Friedman’s book.

Other noteworthy and emerging labor marketplaces:

  • HackerOne(*) is the leading global marketplace that coordinates the world’s largest corporate “bug bounty” programs with a network of the world’s leading hackers. The company was founded in 2012 by Michiel Prins, Jobert Abma, Alex Rice and Merijn Terheggen, and today serves the needs of over 1,000 corporate bug bounty programs. On top of that, the HackerOne network of over 300,000 hackers (adding 600 more each day) has resolved over 100K confirmed vulnerabilities which resulted in over $46 million in awards to these individuals. There is an obvious network effect at work when you bring together the world’s leading programs and the world’s leading hackers on a single platform. The Fortune 500 is quickly learning that having a bug bounty program is an essential step in fighting cyber crime, and that HackerOne is the best place to host their program.
  • Wyzant is a leading Chicago-based marketplace that connects tutors with students around the country. The company was founded by Andrew Geant and Mike Weishuhn in 2005. The company has over 80,000 tutors on its platform and has paid out over $300 million to these professionals. The company started matching students with tutors for in-person sessions, but increasingly these are done “virtually” over the Internet.
  • Stitch Fix (*) is a leading provider of personalized clothing services that was founded by Katrina Lake in 2011. While the company is not primarily a marketplace, each order is hand-curated by a work-at-home “stylist” who works part-time on their own schedule from the comfort of their own home. Stitch Fix’s algorithms match the perfect stylist with each and every customer to help ensure the optimal outcome for each client. As of the end of 2018, Stitch Fix has paid out well over $100 million to their stylists.
  • Swing Education was founded in 2015 with the objective of creating a marketplace for substitute teachers. While it is still early in the company’s journey, they have already established themselves as the leader in the U.S. market. Swing is now at over 1,200 school partners and has filled over 115,000 teacher absence days. They have helped 2,000 substitute teachers get in the classroom in 2018, including 400 educators who earned permits, which Swing willingly financed. While it seems obvious in retrospect, having all substitutes on a single platform creates massive efficiency in a market where previously every single school had to keep their own list and make last minute calls when they had vacancies. And their subs just have to deal with one Swing setup process to get access to subbing opportunities at dozens of local schools and districts.
  • RigUp was founded by Xuan Yong and Mike Witte in Austin, Texas in March of 2014. RigUp is a leading labor marketplace focused on the oilfield services industry. “The company’s platform offers a large network of qualified, insured and compliant contractors and service providers across all upstream, midstream and downstream operations in every oil and gas basin, enabling companies to hire quickly, track contractor compliance, and minimize administrative work.” According to the company, GMV for 2017 was an impressive $150 million, followed by an astounding $600 million in 2018. Often, investors miss out on vertically focused companies like RigUp as they find themselves overly anxious about TAM (total available market). As you can see, that can be a big mistake.
  • VIPKid, which was founded in 2013 by Cindy Mi, is a truly amazing story. The idea is simple and simultaneously brilliant. VIPKid links students in China who want to learn English with native English speaking tutors in the United States and Canada. All sessions are done over the Internet, once again epitomizing Friedman’s very flat world. In November of 2018, the company reported having 60,000 teachers contracted to teach over 500,000 students. Many people believe the company is now well north of a US$1B run rate, which implies that around $1B will pass hands from Chinese parents to western teachers in 2019. That is quite a bit of supplemental income for U.S.-based teachers.

These vertical labor marketplaces are to LinkedIn what companies like Zillow, Expedia, and GrubHub are to Google search. Through a deeper understanding of a particular vertical, a much richer perspective on the quality and differentiation of the participants, and the enablement of transactions — you create an evolved service that has much more value to both sides of the transaction. And for those professionals participating in these markets, your reputation on the vertical service matters way more than your profile on LinkedIn.

NEW EMERGING MARKETPLACES

Having been a fortunate investor in many of the previously mentioned companies (*), Benchmark remains extremely excited about future marketplace opportunities that will unlock wealth on the Internet. Here are an example of two such companies that we have funded in the past few years.

The New York Times describes Hipcamp as “The Sharing Economy Visits the Backcountry.” Hipcamp(*) was founded in 2013 by Alyssa Ravasio as an engine to search across the dozens and dozens of State and National park websites for campsite availability. As Hipcamp gained traction with campers, landowners with land near many of the National and State parks started to reach out to Hipcamp asking if they could list their land on Hipcamp too. Hipcamp now offers access to more than 350k campsites across public and private land, and their most active private land hosts make over $100,000 per year hosting campers. This is a pretty amazing value proposition for both land owners and campers. If you are a rural landowner, here is a way to create “money out of nowhere” with very little capital expenditures. And if you are a camper, what could be better than to camp at a unique, bespoke campsite in your favorite location.

Instawork(*) is an on-demand staffing app for gig workers (professionals) and hospitality businesses (partners). These working professionals seek economic freedom and a better life, and Instawork gives them both — an opportunity to work as much as they like, but on their own terms with regard to when and where. On the business partner side, small business owners/managers/chefs do not have access to reliable sources to help them with talent sourcing and high turnover, and products like  LinkedIn are more focused on white-collar workers. Instawork was cofounded by Sumir Meghani in San Franciso and was a member of the 2015 Y-Combinator class. 2018 was a break-out year for Instawork with 10X revenue growth and 12X growth in Professionals on the platform. The average Instawork Professional is highly engaged on the platform, and typically opens the Instawork app ten times a day. This results in 97% of gigs being matched in less than 24 hours — which is powerfully important to both sides of the network. Also noteworthy, the Professionals on Instawork average 150% of minimum wage, significantly higher than many other labor marketplaces. This higher income allows Instawork Professionals like Jose, to begin to accomplish their dreams.

The Power of These Platforms

As you can see, these numerous marketplaces are a direct extension of the productivity enhancers first uncovered by Adam Smith and David Ricardo. Free trade, specialization, and comparative advantage are all enhanced when we can increase the matching of supply and demand of goods and services as well as eliminate inefficiency and waste caused by misinformation or distance. As a result, productivity naturally improves.

Specific benefits of global internet marketplaces:

    1. Increase wealth distribution (all examples)
    2. Unlock wasted potential of assets (Uber, AirBNB, Rover, and Hipcamp)
    3. Better match of specific workers with specific opportunities (Upwork, WyzAnt, RigUp, VIPKid, Instawork)
    4. Make specific assets reachable and findable (Ebay, Etsy, 1stDibs, Poshmark, GOAT)
    5. Allow for increased specialization (Etsy, Upwork, RigUp)
    6. Enhance supplemental labor opportunities (Uber, Stitch Fix, SwingEducation, Instawork, VIPKid), where the worker is in control of when and where they work
    7. Reduces forfeiture by enhancing utilization (mortgages, car loans, etc) (Uber, AirBnb, Rover, Hipcamp)

If you are a founder who is excited about starting a new marketplace, there are two caveats that are important to remember. First, you will need to find industries where the opportunity to improve the efficiency in the ways noted above is evident. If the network does not create true economic leverage, you will find it hard to be successful. Second, for any marketplace to be successful, the conditions in that given market must be optimal for a new marketplace entrant. Please check out our previous post, All Markets Are Not Created Equal: 10 Factors To Consider When Evaluating Digital Marketplaces, for a list of factors that help distinguish a great opportunity. If after taking in these considerations you think you have found such an opportunity, we would love to talk to you about potentially partnering together. Please send us an email to unlockingwealth@benchmark.com.

(*) Benchmark either is or was an investor in companies labeled with the asterisk.

Interested in “Unlocking Wealth” Yourself?

Benchmark’s Newest General Partner Chetan Puttagunta


This post is by bgurley from Above the Crowd

The partners at Benchmark are pleased to announce Chetan Puttagunta has joined the firm as our newest General Partner.

As early-stage investors, we are acutely aware of the work of other venture capitalists on the boards of the companies we serve. Nearly 15 years ago one of Benchmark’s founding partners, Kevin Harvey, saw the skills of a young Peter Fenton on a board they shared. Peter’s work so impressed Kevin that he recruited Peter to join Benchmark.

More recently, Peter encountered a once-in-a-generation venture capitalist on the board of Elastic, Chetan Puttagunta. In every way, from how Chetan discovered the Elastic opportunity by downloading the product and using it, to how he built a deep trusting relationship with the team, he demonstrated the qualities that define Benchmark and our aspirations to serve entrepreneurs. Chetan’s energy and devotion, his capacity to listen and to provide crisp, well reasoned advice set him apart in that elusive way that leads him to be a CEO’s first phone call.

In addition to Elastic, Chetan, at just 32 years of age, has developed a foundation of successful investments and relationships in the software ecosystem. He led the investment in Mulesoft (acquired by Salesforce for $6.5B) and MongoDB (NASDAQ: MDB). Those founders and CEOs called Chetan “the MVP of our board” and said that, “despite being nearly 20 years younger than everyone else, Chetan managed to deliver insights no one else had.” As the Benchmark partners got to know Chetan better, it became clear that his infectious curiosity, analytical rigor, and boundless energy to serve entrepreneurs fit perfectly with our culture. And Benchmark’s structure – now seven equal partners – means Chetan joins with the same authority, responsibility and ownership as the current partners. We believe Chetan will invest in many of the best enterprise companies of the next decade. And perhaps, he, like Kevin and Peter before him, will spot a future Benchmark partner on one of those company boards.

Our job, as early-stage venture capitalists, does not scale. It is defined by service to entrepreneurs and the teams they build, helping them to realize their vision and the potential of their companies. Whether it is recruiting a key executive, making a strategic decision, or taking a company public, productive and honest dialog between a CEO and a board member can contribute considerably to outcomes. While many venture firms have adopted a stage-agnostic approach, or have hired junior or role-defined staff to help source and support their investments, Benchmark continues to focus on and take pride in the craft of early-stage venture investing. To us, there is no substitute for an active and informed general partner on the board, working side by side with the ambitious, insightful, and often strong-willed entrepreneurs we aspire to serve. We have found a kindred spirit in Chetan as we continue on this mission.

Bill, Eric, Matt, Mitch, Peter, and Sarah

Benchmark’s Newest General Partner Chetan Puttagunta


This post is by bgurley from Above the Crowd

The partners at Benchmark are pleased to announce Chetan Puttagunta has joined the firm as our newest General Partner.

As early-stage investors, we are acutely aware of the work of other venture capitalists on the boards of the companies we serve. Nearly 15 years ago one of Benchmark’s founding partners, Kevin Harvey, saw the skills of a young Peter Fenton on a board they shared. Peter’s work so impressed Kevin that he recruited Peter to join Benchmark.

More recently, Peter encountered a once-in-a-generation venture capitalist on the board of Elastic, Chetan Puttagunta. In every way, from how Chetan discovered the Elastic opportunity by downloading the product and using it, to how he built a deep trusting relationship with the team, he demonstrated the qualities that define Benchmark and our aspirations to serve entrepreneurs. Chetan’s energy and devotion, his capacity to listen and to provide crisp, well reasoned advice set him apart in that elusive way that leads him to be a CEO’s first phone call.

In addition to Elastic, Chetan, at just 32 years of age, has developed a foundation of successful investments and relationships in the software ecosystem. He led the investment in Mulesoft (acquired by Salesforce for $6.5B) and MongoDB (NASDAQ: MDB). Those founders and CEOs called Chetan “the MVP of our board” and said that, “despite being nearly 20 years younger than everyone else, Chetan managed to deliver insights no one else had.” As the Benchmark partners got to know Chetan better, it became clear that his infectious curiosity, analytical rigor, and boundless energy to serve entrepreneurs fit perfectly with our culture. And Benchmark’s structure – now seven equal partners – means Chetan joins with the same authority, responsibility and ownership as the current partners. We believe Chetan will invest in many of the best enterprise companies of the next decade. And perhaps, he, like Kevin and Peter before him, will spot a future Benchmark partner on one of those company boards.

Our job, as early-stage venture capitalists, does not scale. It is defined by service to entrepreneurs and the teams they build, helping them to realize their vision and the potential of their companies. Whether it is recruiting a key executive, making a strategic decision, or taking a company public, productive and honest dialog between a CEO and a board member can contribute considerably to outcomes. While many venture firms have adopted a stage-agnostic approach, or have hired junior or role-defined staff to help source and support their investments, Benchmark continues to focus on and take pride in the craft of early-stage venture investing. To us, there is no substitute for an active and informed general partner on the board, working side by side with the ambitious, insightful, and often strong-willed entrepreneurs we aspire to serve. We have found a kindred spirit in Chetan as we continue on this mission.

Bill, Eric, Matt, Mitch, Peter, and Sarah

The Thing I Love Most About Uber


This post is by bgurley from Above the Crowd

In spite of all the ink that journalists, analysts, and pundits have spilled on Uber over the years, no mainstream article has focused on what I consider to be the most elegant feature of this now ubiquitous, high growth global service — no driver-partner is ever told where or when to work. This is quite remarkable — an entire global network miraculously “level loads” on its own. Driver-partners unilaterally decide when they want to work and where they want to work. The flip side is also true — they have unlimited freedom to choose when they do NOT want to work. Despite the complete lack of a “driver-partner schedule” this system delivers pick-up times that are less than 5 minutes (in most US cities (with populations over 25K) and in 412 cities in 55 other countries. The Uber network, along with Mr. Smith’s invisible hand, is able to elegantly match supply and demand, without the “schedules” and “shifts” that are the norm in most every other industry.

Some have raised questions and concerns about the “gig” economy and the rise of these new independent and autonomous work types. Detractors frequently highlight that these work types lack some of the structured benefits that are frequently attached to traditional full time job offerings. However, what they fail to consider is that there is one critical and fundamental feature of the “gig” economy that is completely absent from traditional job types. That feature — worker autonomy of both time and place — simply does not exist in other industries. One cannot show up for work at Starbucks on a Monday and then decide not to work at all on Tuesday, and for only 2 hours on Wednesday. Oh yeah, and then on Thursday let’s just “play it by ear.” One cannot get a job at Walmart or McDonalds or ironically even as a taxi cab driver without agreeing to some sort of shift or schedule. It is unheard of for an employee to say “I want to work 3 hours this week, 45 the next, and then take 2 weeks off.” This autonomy and freedom of the “gig” work type, which is highly valued by millions and millions of people, would be impossible to implement for the overwhelming majority of companies.

In November of 2014, the Morgan Stanley sell-side research team that focuses on the auto industry, headed by Adam Jonas, made a trip to Detroit to visit the big three automakers. In their own words, “the highlight of the trip, however, was three Uber trips we took between meetings.” They chronicled these three trips in a report they published titled, Confessions of an Uber Driver: Rollin in the ‘D. Interestingly, they encountered three different driver-partners that epitomize why the “where you want, when you want” autonomy of Uber is so fundamentally important. Each of these individuals has a life situation that is supplemented and improved as a result of this super unique flexibility. Included herein is a summary of each driver-partner profile. You will notice that a traditional 9-5 job would have been completely unhelpful to any of the three.

  • The VeteranShe’s a retired US Army Veteran (recently stationed in Germany) and a mother of 3 daughters, the youngest of which is still in middle school. Our driver wanted a job that offered flexibility so she could take her daughter to and from school without relying on the area’s bus system. All of the other jobs she considered made it impossible to be there for her daughter when she needed to be. Uber provides enough flexibility so that she can take jobs when and where she wants while providing substantial income to help make ends meet while her husband, an active member of the US Military, is on tour.
  • The StudentOur driver was a 30-something Jordanian-born student at Henry Ford College studying computer science with an emphasis on internet security and encryption. He’s supporting a family and wanted a job with flexible hours that could accommodate his class schedule and his familial responsibilities.
  • The DeanHere was a dean of students at a charter school in the area who ran into a cash flow deficit for many months while undertaking extensive construction/renovations to his residence. He began ‘Ubering’ last June to make extra cash and has since developed a steady level of business, making around $600 to $700 per week with flexible hours that worked around his time at the school.

In January of 2015, Uber partnered with Alan Krueger, a professor at Princeton University, to conduct the first comprehensive analysis of Uber’s driver-partners, based on both survey data and anonymized, aggregated administrative data. The results from this survey mirrored many of the points that Jonas uncovered and that McKinsey would later uncover. Here are a few key highlights:

  • 85% say they partner with Uber “to have more flexibility in my schedule and balance my work with my life and family”
  • 55% of drivers work less than 15 hours a week, highlighting that a majority of drivers use the service for supplemental income
  • Driver-partners do not turn to Uber out of desperation, only eight percent were unemployed just before they started working with the Uber
  • Two-thirds of these individuals reported that they had a full-time job
  • Reasons for partnering with Uber:
    • “to earn more income to better support myself or my family” (91%)
    • “to be my own boss and set my own schedule” (87%)
    • “to have more flexibility in my schedule and balance my work with my life and family” (85%)
    • “to help maintain a steady income because other sources of income are unstable/unpredictable” (74%)
  • When asked directly, “If both were available to you, at this point in your life, would you rather have a steady 9 to 5 job with some benefits and a set salary or a job where you choose your own schedule and be your own boss?” 73 percent chose the latter.

In October of 2016, McKinsey and Company (working with Uber) published a detailed research report titled, Independent Work: Choice, Necessity and the Gig Economy. The complete work, which is quite detailed and interesting, is publicly available. As the main report is quite lengthy at 138 pages, some readers may prefer the 18-page executive summary. Unsurprisingly, their findings were quite consistent with points already raised above — people value freedom and autonomy. Here is a subset of the relevant findings:

  • The size of the independent workforce is quite large — “up to 162mm individuals, engage in independent work.”
  • McKinsey identified the key feature mentioned above — “A high degree of autonomy: Independent workers have a high degree of control and flexibility in determining their workload and work portfolio.”
  • Supplemental income is a key driver — “More than half of them use independent work to supplement their income rather than earning the primary living from it.”
  • Independent by choice — “Most independent workers have actively chosen their working style and report high levels of satisfaction with it,” “Approximately 70 to 75 percent of independent earners are independent as a matter of preference.”
  • High levels of satisfaction —“Free agents report higher satisfaction than those who choose traditional jobs on 12 of the 14 dimensions we measured, and they are just as satisfied on the remaining two dimensions. Free agents cite higher satisfaction than traditional workers across issues ranging from the creativity they can express to opportunities for learning and recognition. They are happier with their overall level of income and are just as satisfied as traditional workers on income security and benefits. These observations hold regardless of gender, age, education level, or household income.”

Last year, on a trip to New Orleans, I met another driver in a similar situation to those profiled in the Morgan Stanley report. She was a single mother who worked during the week as a nurse. On Friday and Saturday nights, she would drive with Uber until she acquired $100 in earnings, then she would head home. This effort earned her over $800 a month in extra income that helped her support her family. There are no other supplemental job types that are as simple and consistent as Uber is for this single mother. And the impact to her life is real and meaningful.

Another reason Uber is such a great supplemental work type is that peaks in usage elegantly overlap with time windows that are convenient for traditional 9-5pm, Monday-Friday full-time workers. Friday and Saturday nights are simultaneously the consistent weekly peaks of (a) demand on the Uber system, and (b) spare time that is available for people with standard full-time jobs that want to pick up some incremental income (the chart to the right highlights this). The same thing happens with holidays and festivals. The need for rides (and therefore drivers) at music festivals or seasonal events or in a vacation town like Tahoe are bursty. That said, these same holiday weekends are when people searching for supplemental income are free from the primary occupation and can make the voluntary decision to earn more money. I have met drivers in Tahoe that came to town with their family (on vacation) and are earning while others are hiking or skiing. The matching of this excess supply with excess demand is both elegant and fortunate.

There is another incredible driver-partner benefit of the Uber system that is radically different from traditional work types. Uber pays the driver their money immediately when earned. While other employers have experimented with ways to do this from time to time, or once a month — Uber allows this up to 5 times a day. Normal employers are nowhere close on this dimension (most pay 2-3 weeks in arrears). Imagine how this can be helpful to someone who is living paycheck to paycheck in their primary occupation. Not only are the extra earnings in and of themselves useful, but the speed of delivery of the actual cash could mean avoiding nasty traps like usurious payday loans. In fact, based on an analysis of Federal Reserve data, 47 percent of Americans “can’t pay for an unexpected $400 expense through savings or credit cards, without selling something or borrowing money.” Now they have a much better option.

There are many difficult situations in modern life where having a simple, flexible, and consistent form of supplemental income is quite beneficial:

  • A bridge while looking for a full-time job — In the above survey 32 percent of driver-partners indicated a major reason they partner with Uber is “to earn money while looking for a steady, full-time job.”
  • Extra income for a stay at home parent — Many parents are in positions where having a full-time 40-hour week job is incompatible with their duties and responsibilities to their children. Driving with Uber means they are able to have extra income without missing their children’s pick-ups, drop-offs, baseball games or theatre performances. And they can be home in the afternoons to help with homework.
  • Using it to fund their way through college — I have met many driver-partners who are attending college. College is expensive and student debt is extremely high. Students cannot work two days at McDonalds and then skip three days to study for your final — this is “not a thing” with a traditional scheduled job type. Moreover, studying and test schedules can be sporadic and unpredictable. Interestingly — the “elegant balance” characteristic applies here as well. Guess where there are lots of people that should be riding in Ubers instead of driving? College towns. Guess where there are lots of people with extra time that would love to have extra money?
  • Aiding in skills transition/retraining — The notion of skills displacement and digital disruption of certain jobs due to automation or robotics is a hot-button issue. It even comes up with regards to ride sharing as a result of the excitement generated around autonomous vehicles. If people are in need of learning new skills, they would be materially aided by the presence of a flexible and autonomous supplemental income opportunity as they retrain. Nursing school or a vocational training school have all the same issues as going to college. They cost money and demand time — which is super hard to do while maintaining a traditional 40-hour/week full time job.
  • Work your way out of debt — Many Americans are unfortunately saddled with debt — credit card debt and student loan debt. If you are simultaneously living paycheck to paycheck you have no way to “catch up,” and as a result the interest payments chew up the marginal income you would use to pay down the debt. It’s a real trap. Supplemental income — working extra hours while you need to in order to get past a problem like this can be very powerful.
  • Cover an unexpected expense — Sometimes life gives you lemons. You wreck your car. Your refrigerator or washing machine dies. You have an unforeseen medical expense. These are the exact moments where being an Uber driver-partner can get you over the hump. Not forever — just for a few weeks to cover the extra expense.
  • Do what you love — Many of life’s most interesting career pursuits can be the hardest from an earnings perspective. We all know the notions of a “struggling actor” or “struggling artist” or “struggling musician.” Over the years I have met many of Uber’s driver-partners who use the extra earnings power so that they can pursue their dreams. One musician I met would even drive while he was touring on the road — in every city along the way.

The McKinsey study also uncovered these broader societal benefits that come from scalable “independent work” earnings structures:

“Independent work could have benefits for the economy, cushioning unemployment, improving labor force participation, stimulating demand, and raising productivity. Consumers and organizations could benefit from the greater availability of services and improved matching that better fulfills their needs. Workers who choose to be independent value the autonomy and flexibility.”

One thing to note about most of the scenarios above is that they are “temporary.” There is not a desire or intention on the part of the driver-partner to do this as a lifelong career pursuit. Rather, they recognize that it is an amazingly convenient way to solve a temporary need or to help bridge through to another station in life. Some labor lobbyists argue we should turn ride-sharing driving into a scheduled, full-time affair, but in doing so, you would eliminate the key reasons that most people take to the road in the first place. You would also potentially eliminate the world’s premier supplemental work offering.

In just a few short years, over 3 million driver-partners have joined the Uber platform. To put that in perspective, Walmart has grown to 2.3 million employees over 55 years. I think it’s safe to say that over the past five years, no industry has created more new jobs and new income opportunities than ride-sharing. And keep in mind that approximately three-fourths of the industry revenue goes straight to the labor provider — which is higher than almost any other industry on the planet. As a result, in just a few short years, global ride-sharing driver-entrepreneurs have taken in approximately $75+ billion dollars (with industry lifetime revenues north of $100 billion dollars). And keep in mind that ride-sharing only represents around 1% of the miles driven in the United States. As more and more people reduce car usage and abandon car ownership — this number will most certainly go higher and higher.

One interesting thing to note about Uber’s 3 million driver-partners — they all “volunteered” to start driving with Uber. This articulation may sound unusual, but some detractors want you to believe that driving with Uber is equivalent to working in the steel mill in a small mid-western town, where it is the only opportunity for the individual. That is not the case — people are “choosing” to be driver-partners, and they are doing so in record numbers. You have to ignore over 200 years of microeconomic research to be able to contort your brain into believing that all of these people are voluntarily making poor life decisions for themselves.

In all the discussion about why independent work is different than a traditional full time occupation, all of the focus has been on the features and benefits that are absent relative to the historic and perhaps idyllic notion of “work type.” What is missing from the conversation is why this job type is so special and unique to so many millions of people. There is simply no way for the vast majority of employers in the world to offer a completely independent and autonomous work-schedule. They are unlikely to enable “instant payment” either. Yet these are the EXACT same features that show up over and over again in the research as to why people chose independent work in the first place. Independent work is undisputedly “different” from a traditional job type — which is exactly why it is so valuable to so many people.

Driving with Uber reverses the way we have been trained to think about labor. Instead of making labor conform to management’s notion of a ‘job,’ Uber hands control to the worker. You do not have to make your life fit the needs of your job; you can make the job fit the needs of your life. Just how revolutionary this notion is has not, in my opinion, been adequately understood.

“Customer First” Healthcare


This post is by bgurley from Above the Crowd

The subject of the “consumerization of healthcare” has been around for many years. Most frequently people use this phrase in association with personal technology devices (heart-monitors, exercise accessories, sleep monitors, etc) that allow consumers to take direct control of their health information. There is however, a more important trend that relates alternatively to the consumerization of the “business” of healthcare. While other industries often speak of being “customer centric” or “putting the customer first,” the U.S. healthcare system rarely thinks of the patient as a customer. One could go even farther, and suggest that the U.S. healthcare market is the least customer centric of any customer service industry.

David Goldhill, in his enlightening book Catastrophic Care, declared:

“…a guiding principle of any reform should be to put the consumer, not the insurer or the government, at the center of the system. I believe if the government took on the goal of better supporting consumers-by bringing greater transparency and competition to the health-care industry, and by directly subsidizing those who can’t afford care-we’d find that consumers could buy much more of their care directly than we might initially think, and that over time we’d see better care and better service, at lower cost, as a result.”

David makes a powerful assertion — allowing the patient to rise to the forefront and to be truly be seen as a customer — will lead to not only more satisfied patients, but patients with better medical results and much lower costs. This would be a remarkable three-way victory. The good news is we are already headed down this path. The combination of new technologies, data availability, information transparency, shifts in insurance coverage, regulatory reform, and consumer frustration has set the stage for a new era of healthcare service in the U.S. where the patient truly comes first. This powerful trend will gain momentum as it builds, will reshape the current landscape, and will result in the launch of many new and exciting companies.

One overt sign of a lack of traditional market forces is any industry where basic customer service is not a requirement to stay in business. If you asked 100 people to name a place where you frequently wait, even when you are on time for your appointment, how many would say the doctor’s office? The consumer has come to accept waiting at the doctor. We are so numb to the pain, that we rarely object or complain, and the doctor’s indifference to the consumer’s time is so common and widespread, that it is a frequent meme in jokes and cartoons.
Other U.S. industries, once subject to far less competition, have been forced by the market to learn a new reality. The phrase “banker’s hours” is a historic metaphor for “short working day.” One website qualifies “banker’s hours” as 10am-3 pm, which actually were the open hours at most banks decades ago. This is clearly no longer the norm as competition eventually forced a new reality. My local bank is now open 9am-5pm (including Saturdays), and of course, the adoption of ATMs gives us access to cash 24 x 7. All banks have been forced to respond to the new customer expectation, driven by competitive forces. That same shift is now coming to healthcare.

In their marvelous book, Lean Solutions, James Womack and Daniel Jones unpack what it means to apply the discipline of lean manufacturing to service industries. One of their key principles of modern service excellence is “Don’t Waste My Time.” They raise the hypothetical question “Would there be a queue if the providers had to pay customers for waiting time?” If you are in the healthcare industry and find such a question absurd, are you not confirming that you naturally assume your time is much more valuable than your patient’s?

Of course, the healthcare industry’s lack of customer centricity is not limited to time alone. Consider the many business attributes that fall short of other industries, and ask how well your own healthcare service providers deliver against these questions:

  • Hours/Appointments — For your provider, what hours are they open? Are they available when its most convenient for you? Do they expect you to miss work or school to come see them? How far in advance do you have to book an appointment (the average is 24 days)? Can you simply “walk in” for appointments?
  • Interactive Booking — Can you book appointments online? Can you cancel or reschedule online?
  • Information Collection — Does your doctor make it easy to provide information about your visit? Can you do this online before your visit, or are you handed a clip-board full of forms where you enter information you have already provided on previous visits?
  • Electronic Communication — Can you send your healthcare provider email? Do they respond? Do they even make an email address available? Can you even leave a voicemail?
  • Response Time — How quickly do they follow up to a request? Do they have a consistent guarantee on time to appointment? What about in response to a question via email or phone?
  • Pricing Transparency — Have you ever seen a menu of pricing for any healthcare services? Why not? In many other countries, price lists of common procedures are publicly available in every clinic and office. If you are on a high-deductible plan or a Flexible Spending Account this is important information to you.
  • Information Sharing — Does your doctor send you a detailed “receipt” of the procedures they performed, their discoveries, their analysis, and their conclusions so that you have an archive? Do you even get a list of the charges they are submitting to your insurance company? Are the charges ever discussed or explained?
  • Empathy — Do you find that your healthcare provider makes a concerted effort to treat you as a customer with enthusiasm and empathy? A recent study of online physician reviews found that 96% of complaints relate to customer service, and only 4% to quality of care.
  • Service Level – Do your doctors ask you for feedback? Do they conduct surveys? Do they measure waiting time? Do they measure NPS scores?
Technology to the Rescue?

One obvious solution to this list of issues and opportunities is to leverage technology to better serve the needs of the customer. Unfortunately, a deep dive into the large and complex market for healthcare IT systems will uncover an unfortunate reality. You will not find a large Salesforce or Zendesk of healthcare. Customer-facing, also known as “front office,” systems have not been the focus of healthcare service providers historical spend. Most large healthcare IT systems are chosen based on one primary objective: revenue management. Billing and collection in the U.S. healthcare system is complex and difficult, and most of these large EHR systems’ number one purpose is to deliver revenue. Unfortunately, as these systems better perform their inherent duty, they actually drive healthcare spending as a % of GDP up, not down. They contribute to the overall problem.

Revenue-management obsession even has a negative impact on how quickly healthcare organizations embrace technology – technology that could radically improve the customer experience. Do you want to know the real reason doctors do not answer email? Want to know the real reason telemedicine is not widely pervasive? Clearly, many doctor visits could be replaced by a 10 minute FaceTime call, saving the patient and the practice a great deal of time (not just the time in the office, but the commute time in both directions). You may be surprised, but the primary reason these technologies go unadopted is because doctors simply do not know how to charge for them. The problem is primarily an absence of easy reimbursement.

Who Is the Actual Customer?

Despite widespread belief to the contrary, the U.S. healthcare system does not operate as a free marketplace with the type of open-competition that we often associate with capitalism. It is certainly not a single-payer system, but that fact alone does not make it a capitalistic system. There is no price evaluation during the purchase. The person paying is not the person consuming the service, and the majority of choices are made without comparative options. In many ways, we have the worst of both worlds. Our system, which is the highest in the world as a % of GDP, has the illusion of a free market and the illusion of regulated market with the apparent benefit of neither.

The fact that the employer plays a central role in our healthcare system is both a coincidence and a likely impediment to forward progress. In 1942, President Roosevelt worked with Congress to pass the Stabilization Act of 1942. Hoping to provide incentives for full employment and to ward off inflation, the government froze wages while simultaneously leaving open a back-door for increases in benefits. This seemingly innocuous legislation had a far-reaching consequence — it launched the widespread U.S. practice of employer sponsored health care coverage. And today, for most employers, this benefit is explicitly required by law. While it seems normal to us, the use of the employer as a key constituent in providing consumer healthcare coverage is quite rare and not used in any other industrialized nation.

Obviously, having a reluctant and unnecessary third-party involved is not likely to deliver peak efficiency. Most employers would opt out of providing health insurance if they could. They have no specific expertise in the matter, and being a provider of these services puts the company in the awkward position of having a point of view on private personal matters as well as what defines basic well being. Additionally, the large employer motivations are likely contributing to rising costs. A large employer benefits plan needs to be “competitive.” If there happens to be a large, renowned hospital group in the area, the employer feels compelled to offer coverage that includes this institution, even if that system is highly over-priced (the largest hospital systems typically have the highest procedural prices).

In the U.S. healthcare system there is complete obfuscation and confusion regarding who the real customer is. The employee picks a provider from a plan picked by the employer from the insurance carrier. The consumer sees no prices as it makes choices and decisions. The payment and reimbursement process involves all four parties. Quite often, the carrier “rejects” the reimbursement request sent in by the doctor. This is then sent though the employer to the employee. Now the employee is exposed to the price for the very first time, and told the price was too high, but guess what — this is after the work is already done. Now the employee has the joy of negotiating after the fact.

If you were a U.S. healthcare provider, who would you view as the customer? The employer bears the eventual costs. The insurance carriers process the payment. The employee uses the service, but they did not chose you based on the prices of your services, and you never discussed or disclosed price to them. Those prices were negotiated between you and the different carriers that placed you on the various plans chosen by the employer. As you can see, its not unreasonable that, as a provider, you would not actually view the employee that utilizes your services as the customer. They are far from your only constituent in the system, and they are absolutely NOT the party that is paying the bill or negotiating price.

Winds of Change

As mentioned in the introduction, we have a strong belief that change is afoot in the U.S. healthcare market. Specifically, we believe a number of factors are coming together simultaneously that will drive healthcare providers to respond to market forces and adopt a “customer-first” mindset. Recognizing patients as “true customers,” service providers will provide unprecedented responsiveness, conveniences, service levels, and information transparency. Those that adopt this mentality will find new levels of productivity, and as a result, will deliver higher quality care at lower and lower prices. Those that choose not to align with this new reality will fall behind, eventually losing customers to these more nimble and responsive providers.

Here are a list of the new forces pushing the U.S. healthcare system to be customer-first:

  • High-Deductible Plans — In order to reduce insurance premiums and make catastophic healthcare available to more individuals, high-deductible plans have been growing as a percentage of all plans. In 2015, 46 percent of workers were enrolled in a plan with an annual deductible of $1,000 or more, up from 38 percent in 2013 and 22 percent in 2009. The Affordable Care Act’s (ACA) most affordable plans are all high-deductible (even though many citizens did not realize this when it was passed). As such, the ACA has been a key driver for the continued rise of high-deductible plans. The interesting (and perhaps unintended) consequence of high-deductible plans is that patients become real “consumers” for the very first time — at least up until their deductible. Having never been trained to be price aware, and with most providers loathe to publish price lists, this is an interesting evolution for the industry. But certain providers are stepping into the void, and they are growing market share as a result (more below).
  • Growing Coinsurance — Like high-deductible plans, coinsurance is another way of offloading, or sharing, healthcare costs with the patient. Coninsurance plans require the patient to pay a percentage (usually 10-30%) of the healthcare costs up to the deductible limit. Also like high deductibles, coinsurance usage in on the rise. From 2004 to 2014, the average payments for coinsurance rose 107% from $117 to $242. Increasing coinsurance costs also have the effect of turning patients into shoppers/consumers. When you absorb a percentage of the costs, you will pay more attention to price.
  • FSAs/HSAs — Flexible Spending Accounts, also referred to as Health Savings Accounts, are pools of money set aside by an employee and their employer to be used for healthcare spending. The employee is typically allowed to allocate money to these accounts pre-tax (up to a limit), and as specified in the ACA, $500 in unused funds can now be rolled over into the next year. While these plans have historically been targeted as “non-covered” expenses, they are increasingly being used for deductibles, copayments, and coinsurance, which as we stated are already growing as a percentage of contribution. As like the previous two points, the rise of these spending vehicles once again pushes the healthcare patient to think more and more like a shopper. Spending wisely allows them to get more and more products and services under their given plan or program.
  • Narrow Networks — Narrow networks are an interesting response to the above market prices that the large hospitals and groups are pushing on the broader market. With a narrow network plan, the consumer or employee is allowed to “opt-in” to a plan that has lower premiums, with the explicit tradeoff that this plan has fewer choices for service providers. Specifically, the “narrow network” typically aggregates those providers that are willing to accept lower prices for their services (theoretically you could have a “premium” narrow network, but they are typically used to create more affordable plans). Some employers even offer the employee a benefit to choose these plans, in essence sharing the savings with the employee. Obviously, if narrow networks increase in popularity, more and more market share shifts to providers that are willing to respond to competitive market-based price demands. These are highly likely to be the same exact providers that are embracing these other market forces.
  • Rise of Urgent Care — Urgent Care facilities, originally created for the purpose of providing a less intimidating alternative to the Emergency Room for off-hour care, are increasingly serving the basic healthcare needs of an ever growing percentage of healthcare consumers. This reality might not sit well with those that embrace the idyllic notion of the “family doctor,” but just remember that same idyllic doctor used to do house calls. On several dimensions, these urgent care providers are creating an offering that is not simply on-par with your traditional GP, but often materially better. Consumers come to an urgent care facility during an emergency, but the experience is so great, they come back for everyday healthcare needs. Some members of the “urgent care” community are intelligently rebranding their services as “convenient care.” This progressive market entrant puts positive pressure on the overall health care system.
    1. These providers are often located in more convenient locations with better parking options for the consumer.
    2. They are more likely to disclose, or perhaps even advertise their prices.
    3. Following their legacy of after hours care, they often have broader hours than a traditional GP. As an example consider Pediatrics After Hours which operates in Dallas as a pediatric urgent care facility. They are open from 4:30-10:30pm, Monday through Friday, Saturday from noon-10pm and Sunday from 10am-9pm. Now if you are a working parent who prefers to not take their kids from school for medical visits (or simply can’t take them due to work), how do these hours sound?
    4. Most urgent care facilities allow non-appointment walk in visits (does your GP?). They also allow online booking.
    5. An increasing number of urgent care facilities measure wait time, ask for consumer feedback surveys, and even calculate NPS (net promoter score) in an effort to deliver a superior customer experience.
    6. Both CVS and Walmart have entered the urgent care race with their retail clinics. CVS operates MinuteClinic at over 1,100 locations in 33 states, and they have seen over 20 million patients. They are open 7 days a week, including evenings and weekends. No appointment necessary. Likewise Walmart operates Care Clinic in many of its stores. Both offer pricing online.
    7. Integrated managed care providers like Kaiser Permanente, HealthPartners (MN), UPMC (PA), and Baylor Scott & White (TX) have all added “Urgent Care” locations as part of their broad mix of offerings. Clearly the market is speaking.
    8. Many of these “Urgent Care” providers prefer to be thought of as “Convenient Care” providers, highlighting their differentiation and their move from solely episodic usage to more of default provider of health services.
  • Growing Use of CRM Type Tools — While not historically a key priority, leading healthcare providers are beginning to adopt “front office” technologies that are used to provide better customer service. These tools might enable online booking, provide the ability for more frequent customer-provider communication, facilitate surveys and feedback, automate follow-up correspondence, and anticipate customer needs. As consumers experience these higher levels of “customer-touch” they will likely grow accustomed to them and expect them from all providers.
  • Internet Web Sites/User Generated Content (UGC) — On the internet, information availability evolves in one direction only — more and more. Over time, as more providers embrace customer feedback, and as more consumers are willing to share their opinion, we will begin to see more and more customer feedback on healthcare providers. Today, 77% of consumers say they use online reviews as the first step in finding a new physician. Additionally, as price schedules become “expected” the leading players will embrace publishing their price schedules to the public. This reality is already present in most service provider industries, so it should be no suprise when it arrives full throttle in healthcare.
CVS Care Clinic Price Schedule:
Benchmark Healthcare Investments

Our venture capital firm, Benchmark, has made four investments consistent with the “customer-first” theme.

  • Brighter — Brighter is a cloud-based health insurance platform that seamlessly connects patients and doctors to dramatically improve the patient and provider experience while reducing costs for patient, provider and insurer. The company provides its integrated suite of services to leading health services organizations such as Cigna, Aetna and Delta that include enhanced provider search and directory, verified patient reviews, price and quality transparency, online appointment scheduling and patient communications transforming a traditional health benefit into a digital health plan. Brighter has rapidly achieved national scale with distribution to tens of millions of insured patients and over 100,000 providers.  Note: Last Thursday, Cigna acquired Brighter to accelerate the development of Cigna’s mobile and desktop platforms and create new end-to-end experiences that connect health consumers and providers with the guidance, support, and incentives they need to increase quality of care and maximize cost-savings.
  • OneMedical — One Medical is a member-based and technology-enabled primary care network that challenges the notion that delivering high-quality, accessible health care is either unachievable or prohibitively expensive. In fact, they are working to prove that just the opposite is possible — a system where quality care is affordable and available to everyone. By 2018, they will operate 75 offices in 8 markets with over 400 primary care clinicians. They are typically located in urban areas near consumer’s place of work but are also in residential areas. They typically see appointments within 60 seconds of scheduled appointment time and respond to clinical communications in less than two hours, while offering 24×7 virtual care from its employed clinicians often within 60 seconds. As a result of their commitment to service quality, they have a 90 net promoter score. They also drive much lower costs through the use of better analysis, information, and care that helps reduce unnecessary costs with regards to downstream specialists, hospital utilization, and diagnostic testing.
  • Solv — Solv is a marketplace for same-day healthcare, connecting patients to urgent care clinics and providers who are committed to delivering a convenient and high quality experience. For consumers, Solv answers simple questions which, until now, have been very frustrating in healthcare: where should I go, when can I be seen and how much will it cost me? For providers, Solv’s software improves the in-clinic experience via mobile-first scheduling, online paperwork, wait time reduction and feedback collection. Solv launched in Dallas-Fort Worth earlier this year and quickly expanded nationally after providers across the country requested their consumer-centric healthcare platform. When people get sick, they typically wait days to see a primary care physician, waste hundreds of dollars at an emergency room, or need to juggle their life to fit a visit into their schedule. Solv’s mission is to make access to high quality, last minute care simple, fast and effortless by connecting consumers to their national network of providers, who are eager to provide the service.
  • Stitch Health — Our most recent healthcare investment, Stitch is a Y-Combinator seeded SaaS company that serves as home base for healthcare teams that aim to deliver customer-first healthcare. The company is HIPAA-compliant, cross-platform (desktop, iOS, or Android), searchable by patient ID, and integrates with existing electronic health records (EHRs). Stitch replaces the fragmented use of pagers, phone calls, EHR message baskets, and emails with a single product. It does this through a user-friendly application that models medical provider workflow and presents patient health data in the context of group chats, direct messaging, private groups, and persistent chat rooms. By making a product that solves the problem of archaic, fragmented tools in the healthcare system, Stitch hopes to make it easy for healthcare teams to provide exceptional care.

As venture capital investors, we value investment opportunities that are exposed to huge shifts in a given market — particularly really large markets such as the U.S. healthcare market. The timing can be tricky, however. You need to enter the market when (1) consumers are showing a unquestionable favoritism for a new approach, (2) they are voting with their pocketbooks in favor of this new approach, and (3) the incumbents in the market recognize the trend is unstoppable and begin to react (rather than deny or ignore) that trend (which creates the “tipping” force). We believe all these things are currently in place with regards to “customer first” healthcare. Moreover, because of the systematic changes outlined above, the U.S. healthcare consumer is emerging as a true “shopper” for the very first time. This will add fuel to the fire and accelerate the transformation. We are willing to bet on it.


Background: I spent the better part of two-years surveying the Healthcare market in search of an investable opportunity or possibly a key investable theme. At 18% of GDP and rising, it seemed tautological that many entrepreneurial opportunities should exist to use today’s technologies, applications, and devices to build many value-added companies. The first part of this journey was both tedious and eye-opening. This US healthcare market is as flawed and complex as it is large. If you are interested in my overall learnings from that journey, listen to the podcast (transcript also available) I did with Ezra Klein for Vox’s The Ezra Klein Show. In the second part of that same journey, I stumbled upon what I believe to be a large and investible trend — and that is the key subject of this blog post.

The Ezra Klein Show: VC Bill Gurley on Transforming Health Care


This post is by bgurley from Above the Crowd

In November of 2015, I posted a tweet that declared Benchmark was interested in discovering Internet healthcare investments. Our firm has had the good fortune to invest in many two-sided networks that used information aggregation, supplier aggregation, and user generated content to attract and inform consumers and resultantly disrupt and change different industries. Examples of such companies include Yelp, OpenTable, GrubHub, 1stDibs, DogVacay/Rover, Zillow, and Uber. It only seemed logical to us that the same opportunity should exist in healthcare. Most people are aware that healthcare spending in the U.S. has risen to 17-18% of GDP and is grossly out of line with other comparable nations. Additionally, all of us that have been consumers of the U.S. system are blindingly aware that numerous inefficiencies exist in the system. Simply put, there is amble room for improvement. So if Internet and mobile technologies can be used to change real estate or transportation, why not healthcare?

Over the next two years, I looked at many healthcare IT investment opportunities – I went “all in.” It’s worth noting that our primary focus was on technologies that aided and improved primary care, which is about half of the U.S. market in terms of revenue dollars (there is no question that digital tools will successfully impact specific acute diseases/disorders, but it’s our intuition these are best left to 100% focused HC investors). At first, this deep dive proved frustrating. The more we learned, the more we realized how much we did not really understand. The U.S. healthcare system is confusing and complex. Eventually, however, we gained our footing and developed a mental model for the industry and a framework for where opportunities do exist. We also discovered what we believe is a large and investible trend/theme. In May of this year, Ezra Klien, who is remarkably informed and intelligent on the topic of healthcare, was kind enough to include me on his podcast to discuss and debate my learnings. That podcast is included here along with a transcript.

 

 

Ezra Klein:  Hello and welcome to the Ezra Klein Show, a podcast on Vox Media Podcast Network. I am Ezra Klein and my guest this week is Bill Gurley. Bill is a general partner at Benchmark, one of Silicon Valley’s really legendary venture capital firms. He is one of Silicon Valley’s legendary venture capitalists. He was named the venture capitalist of the year in 2016 at the TechCrunch’s annual Crunchy awards. He’s been an early investor in Grubhub, OpenTable,Uber, and Zillow and all kinds of things. A very, very smart guy, a very thoughtful guy. We’ve been talking recently because he’s been thinking a lot about healthcare.

They’ve recently made some investments in that space. The reason I wanted to have him on was that we have been having this conversation in Washington about how do you reform the healthcare system? What would a better healthcare system look like? What would a cheaper healthcare system look like. It is a very narrow conversation. It is had from a very policy-oriented perspective, what can we write into a law? It is made by people who I think often have a pretty limited set of views and experiences on the topic. Gurley’s been attacking this from another perspective, that of the entrepreneur. Where can you actually enter the system? Where can somebody come in and make something better and make some money off of it? He’s been working on this now for a couple of years.

I thought this would be a good way to think about this from a broader perspective. Think about what is possible and what isn’t. You’ll hear in here that Bill and I have somewhat different views on this. I am pretty skeptical of consumer driven healthcare systems. I think that is not what people want in healthcare and as such it is not what we are going to get. He has a different view, and I think it is an interesting one. We talk a lot about the Singaporean healthcare system, which has become definitely an obsession of mine. He talks about his view that maybe democracy [and capitalism are just going to eat each other alive. We should be looking at China for the real innovations now.

It’s a fun interesting conversation. I like healthcare a lot. I talk more than I typically try to, even though I typically talk a lot in this podcast, but I hope you enjoy it a lot anyway. Before we jump into it. A quick couple of plugs. Check out my other podcast The Weeds, which also has a great discussion of the Singaporean healthcare system. You can download The Weeds live episode for that. My colleague at Vox, Tod VanDerWerff, our critic at large, has a great new podcast called I Think You’re Interesting. He has an interview with a bunch of the Samantha Bee writers recently. That is a great interview. I think if you’re into the folks that I’m talking to, you’ll be into that one. Again that is I Think You’re Interesting by Tod VanDerWerff. You can get it wherever fine podcasts are downloaded. Without further ado, here is Bill Gurley. Bill Gurley, welcome to the podcast.

Bill Gurley:  Thank you, Ezra. Appreciate it.

Ezra Klein:  When we talked recently you told me that you’ve been on a multi-year learning deep dive on healthcare. Tell me a bit about that. What got you interested and how have you been studying the system?

Bill Gurley:  Great. Our firm has been fortunate enough to be an investor in numerous “marketplaces”. I think it started with eBay, but then we got into more vertical specific ones, like Zillow, Grubhub, OpenTable and Uber that I’m on the board of. When you’ve had some successful marketplace investing, you start to say, “Okay, well what are the biggest segments of our economy and is there an opportunity to do something similar against those different industries?” And one that kind of stands out like a sore thumb is healthcare because it’s risen to whatever the latest number is, 17% or 18% of GDP. The other thing that’s pretty obvious, I think, for any entrepreneur, you say, “Wow, look, there’s a lot of room for disruption.” The reason people come to that kind of natural conclusion is because they see waste or they see inefficiency or they see a lack of transparency.

These are areas where digital tools have had an impact on other industries. I think the core thesis is one that’s almost tautological that, “Oh, yeah, you should be able to use these technologies,” smartphones, websites, the internet, transparency, pricing aggregation, reviews, and have some type of impact. But that’s really just the starting point and that’s when I put out a Tweet three years ago and started meeting with digital healthcare [00:05:00] startups.

Ezra Klein:  What was that Tweet?

Bill Gurley:  Oh, I think I said, “I’m interested in looking at digital healthcare startups,” and created an email that was I think healthcare@benchmark.com and just kind of opened the flood gates on purpose.

Ezra Klein:  Did you get interesting responses to that?

Bill Gurley:  I did, and I should caveat that there are a number of great venture firms that get really focused on things like biotechnology and drugs and pharma, and we’re not going to do that. Benchmark has historically been a tech-based startup, so I’ve been mostly looking at ways that digital technologies could impact the healthcare system, not at products or drugs or things like that.

Ezra Klein:  Tell me a little bit about the learning journey that emerged from this. What did you learn that surprised you?

Bill Gurley:  There’s this interesting theory people have that the first part of your learning, your confidence [00:06:00] of what you know actually drops instead of rises and I certainly went down that curve. I would say it probably wasn’t until I was two years into the process that I even had confidence to write a check, to make a decision as a venture capitalist, because the first couple years all I learned was shocking and confusing and I’m realizing that was very different from a normal world.

I got very lucky early on because someone introduced me to a book by David Goldhill called “Catastrophic Care.” What’s interesting about the book is David’s an outsider. His fathe, unfortunately, got into a really bad incident involving the healthcare system and he went deep. He runs the Game Show Network. He’s a really odd person to write a healthcare book, but he wrote a fascinating book and I think uncovered all the things about the US healthcare system that kind of undermine its success. He’s done podcasts and stuff and I urge you to check out his stuff.

Some of the big things that come up, I first and foremost say it’s not a competitive market. I think people have the perspective, especially … I’ll opine on Washington for a second because I think a lot of people that write healthcare policy, they think it’s an open market, but you really don’t have … The consumer doesn’t know price when it makes a decision. The consumer’s not the payer. The payer is the employer. The employer is in the system for what reason exactly? It’s super complex, the way people get paid, the way people make decisions, and completely different from every other industry in North America. That creates a ton of problems.

There’s no price transparency, that’s another big one. I think the current system is self-reinforcing. It’s getting bigger and bigger because of the way the dynamics bounce against one another. That would require a deeper dive to explain.

Ezra Klein:  We’re a pretty deep dive place, but maybe I can unpack a little of that for folks who I think … Maybe there’s a little shorthand there, which is that healthcare has emerged in this very weird way in America where you tend to have third party payers. In between you and the healthcare system, say you have your employer, right? I get my healthcare insurance through Vox Media, so I actually don’t know the cost of my healthcare, or the government-

Bill Gurley:  Let’s talk about that for a minute. I did some research, I wouldn’t have known this innately. We’re one of the only countries in the G20 where the employer’s involved. You say-

Ezra Klein:   That’s like a weird World War II tax quirk.

Bill Gurley:  Yes, yes. Coming out of World War II, the president was definitely afraid of inflation and so there was mandated wage restriction. You couldn’t increase wages, and that was mandated by the government. People [00:09:00] started throwing in benefits. Low and behold, here we are 70 years later and we get our healthcare from our employer. We don’t get laundry services, we don’t get our lawnmower, we don’t buy clothes through our employer.

Ezra Klein:  Although I guess in tech sometimes you do get your laundry done over there.

Bill Gurley:  Fair enough. I think that’s being weaned off.

Ezra Klein:  Sure.

Bill Gurley:  Yeah, we’ve got this extra person involved for no reason and, of course, a lot of the problems stem from that.

Ezra Klein:  I tend to agree with this, but there are two ways of looking at it. One is a way that my conservative friends often look at it. Virtually every healthcare expert I know agrees that that tax break, moving the system to the employer, is the original sin of American healthcare policy, that almost every bad thing flows from right there. My conservative friends look at that and they say, “Well, if we hadn’t done that, maybe we could have a real market-based, patient-centered, consumer-driven system.” And my liberal friends look at that and they say, “If we had not created this halfway measure of health security, we would have what every other country has,” which seems to work well in other places, which is a government-run system where health protection insurance is guaranteed in some way or another, the exact structures differ, but by the state.

This is, I think, an interesting divergent branching, because Goldhill who wrote that great Atlantic article and then his book, which I do recommend people read, sort of takes it in that other direction. He says, “If we didn’t have that, then maybe we could really shop for healthcare the way we shop for TVs, the way we shop for food, the way we shop for furniture, and the system would meet our needs as consumers, and that would be great. A lot of people argue that point.

Talk to me a little bit about how you came to the view, or whether you hold the view, that that is what we need, that a consumer-centered healthcare system is actually a good thing as opposed to a category of some kind.

Bill Gurley:  Our system, which is the highest in the world as a percentage of GDP, has the illusion of the free market, the illusion of being highly regulated, and the apparent benefit of neither. My answer to what you just said is we have a faux marketplace right now and I think there’s tons of data that says making it more competitive ala Singapore would be better, or making it single payer ala a bunch of other countries would be better. And I have to agree with both of those assertions. What seems obvious is the current state of our system is not the right answer.

Ezra Klein:  Well, that I certainly agree with. I want to put a pin in Singapore and come back to it. Let’s talk about David Goldhill for a minute, and it’s been a minute since I read his work, but he believes that we should have a system that is built around catastrophic care, very, very, very high deductible catastrophic care. He talks at times about tens of thousands of dollars of deductible.

The question I want to pose to you is maybe the reason healthcare evolves in this different way is that it’s not a normal good in the way people treat it. That as a society we are okay with the idea that you can’t purchase a television, we’re okay with the idea that you can’t purchase a nice couch, but we’re not okay with the idea on some fundamental level that you get cancer and you can’t pay for care, or even lower than that, that you break your leg and you can’t get it put in a cast by a reputable doctor. And that what people are looking for in healthcare, and I think this often foils the market, is security above all, where in other places they’re willing to take risk, they’re willing to take chances. I think something that keeps becoming a problem for various sort of consumer-driven initiatives here is that people demand a level of security and predictability and reliability out of [healthcare that keeps them from being able to walk out of a doctor’s office and say no, or keeps them from being willing to accept the consequences of a market, which, after all, rely to some degree on scarcity.

Bill Gurley:  Yeah. I have two initial reactions to that. One, the more I read about people coming up with solutions for healthcare, a lot of times I see someone that believes in one answer, demonizing the other. We end up just doing neither because we’re pointing fingers back and forth. I could see an argument for having some price controls and more competition. I don’t know that these things have to be at odds with one another. So that would be my first assertion.

The second thing I would say is there is certainly an argument that competition can drive quality and results and price. It doesn’t have to be true that having more competition will lead to some type of worse outcome versus not having it. In fact, a lot of people believe that the way you get to higher and higher efficiencies is through that competitive process. I would point to the thing that’s most frequently commented on in this type of conversation, which is LASIK, where the price and execution of LASIK today, which is typically bought not through insurance, but bought by people as a competitive good, has been driven down and down and down. There’s shining a laser in your eye. This isn’t like super simple and arguably it’s much safer today than when they first started.

Ezra Klein:  Yeah, LASIK is such a fascinating example, and people bring it up and I think you’re right to focus on it. It has a couple of qualities that I’d be curious to hear how you think about them. One is that it is optional, right? I have glasses and I think a lot about getting LASIK and I am just squeamish about getting a laser cut into my eye, so I haven’t done it, which is different than say cardiovascular health treatment.

Bill Gurley:  Absolutely.

Ezra Klein:  There is a quality of being able to say no and being able to shop around and being able to do things on your timetable that really matters here, but the other thing that I think is interesting there, because here’s where I think possibly liberals can take this argument too far. There are a lot of pieces of the healthcare market or healthcare services that could be pulled out, like LASIK, and one thing that some places, and I think when we get to Singapore we can talk more about this, too, is primary care can be treated very, very differently than more specialty care or more catastrophic or chronic disease care. I think one of the questions the LASIK example brings up is are there ways to cut the healthcare system up a little bit differently? Are there ways for more things to be pulled out of third party payer model and it’s something you get through HSAs or there’s some other way of making it affordable for more people, but because it has this optional asynchronous quality to it, we can expose it more to market forces without saying at the moment you do that, that that also means if you get cancer and you can’t pay for it, you’re out of luck?

Bill Gurley:  Right. Well, look, I think that the high deductible plans do that somewhat in that if you’re having cardiovascular work or if you have a premature birth, you’re over that cap. You’re into that system. And things that are going to live underneath that are going to be more of your primary care. I think about 50% of our market is acute care and about 50% is primary care, so maybe the place … And I think that makes a lot of sense, right? The place where competition and hopefully consumerization, and when I use that word I mean providers that care about the consumer experience, that can happen down in this primary care bucket, which is half of the system.

This is, I think, a good moment to go a little bit back to your story. There’s a lot I want to follow up in here, but I also want to track what you’ve been doing. You went through a couple years where initially you looked at this and said, “This market is nuts. This system doesn’t make any sense. I’m not sure there is a way to expose it to entrepreneurship or there is an inlet for you.” What began to convince you that something was changing or that there was an opening? What was sort of the crack in the armor for you?

Bill Gurley:  Do you mind if I … Can I go back and I want to talk about a couple other things that I saw? Because I think that it’s important for everybody-

Ezra Klein:  Yeah, that’s totally … I do not believe in linear conversations.

Bill Gurley:  Okay. The first one is to really understand how big hospitals and big insurance carriers and big employers are all feeding on one another to make the system worse and worse and worse. The way the system’s designed, it’s just instinctive for them to do this. Most large hospital systems are getting as big as they possibly can. Stanford here in our backyard is gathering up general practitioners, specialists, they’re literally getting as many people into their system as they possibly can. You can drive 30 or 40 miles from the Stanford campus and you’ll see a new hospital going up with the Stanford name on it. You say to yourself, “Why are they getting bigger?”

Well, there’s two things: It gives them leverage with the carrier, but also if their footprint is that big, no employer around here is going to walk a narrow network plan that doesn’t have Stanford Hospital System in it. You see this kind of … And, by the way, if you are a startup that wants to sell to an individual general practitioner, you should know that they’re actually on the wane. There’s fewer and fewer individuals. They’re all getting sucked into these big systems, partially because they don’t want to go through the struggle of getting paid and if they can be a part of this big system, then they’re going to have a much easier time getting paid, because that system has more leverage with the carriers and the employers.

It turns out, if you go deep on pricing, if you open a Castlight app and you look at these large hospital systems, you will see over and over again, and this has been written in a number of the articles I’m sure you’ve read, an 8 to 1 delta in pricing, 8 to 1 versus the low end of the market. It’s unbelievable, right? Someone can charge $3,200 for an MRI when you could get it for $400. By the way, if your general practitioner gets pulled into one of these big systems, they’re going to recommend you get your imaging at that system and you wonder how-

Ezra Klein:  Can I hold … Let me push you on one question about his, Bill, because I think this is fascinating. We’ve done a lot of work with the Castlight data and I actually completely agree with the larger point that all the pricing is crazy. But there is this kind of thing in healthcare where people get really shocked that MRIs cost different amounts in different places, but we’re not shocked by that in cars. We’re not shocked … By that I mean, you can go into San Francisco and you can buy a burger at McDonald’s for a buck and you can go then a couple blocks down and buy a burger for $27.

Tell me what it is that shocked you about it, because you’re a guy who … You’re in the business world. People price differentiate all the time. Isn’t Stanford just giving you better MRIs? Wouldn’t that be their argument?

Bill Gurley:  Do you believe that?

Ezra Klein:  No, but I want you to say it.

Bill Gurley:  Okay.

Ezra Klein:  But I think it could be conceptually possible.

Bill Gurley:  They’re buying the equipment … They’re not making the equipment, they’re buying the imaging equipment. They’re just running you through it. I don’t believe that the reason that is 8X price is because it’s 8X better. I do not believe that. I believe it’s 8X priced because they can charge it.

Ezra Klein:  So you think what’s happening is a kind of … You think this is the power of concentration, that these systems are getting big enough that it is just easier for the third party payer to pay them off than to turn around and say to their employees, say, for Vox Media to see to me, “Hey, I know you want to go to the dominant hospital system in your area, but we decided it was too expensive and now you can’t.”

Bill Gurley:  Look, this is part of where getting the employer out of the game might be helpful, right? I think narrow networks play a really important, or they represent a really important opportunity to get pricing down. If you talk to a benefits provider at a large company, and I did this as part of my process, I probably had 10 or 15 meetings with these benefits providers, first of all, none of them want to be in this game. This is the most reluctant task that any company has to do. They do not want to be in this game. They are forced into it. Second, their number one task as an employer is to not lose competitive situations for new employees because their benefits aren’t good enough.

The number of companies who are maybe self-insured that are willing to push the edge in terms of trying to redefine cost I bet you is 10 or 20. You heard about the Safeway story probably. Remarkable outlier. They’re just not going to go break their pick to redefine the system from where they sit. They don’t have the authority within the organization to make that their missive, does that make sense?

Ezra Klein:  Yeah, but this is so interesting. I’d like you to hold on it for a minute, because I think this is important to what should be the central mystery of all this. In some stylized model of the American healthcare system, what you might say is, “Okay, individuals do not pay for their own care and they do not have full incentives to bring down the cost of their own care.” They have some incentive, but they’re a little bit insulated. But, employers sure as hell do. And employers have these whole HR departments, so they have all this information and all this expertise and they even have more negotiating leverage than an individual does. You could really imagine a world in which employers were more efficient, not less efficient, at getting good costs on insurance, on negotiating better prices. They have the expertise and they have the incentive and they have the size. Yet, we don’t see this world.

It, to some degree, is one of the persistent mysteries in the healthcare system, but a little bit like you’re saying, this is in the HR department and the HR department does not want everybody screaming and yelling and then the CEO comes and says, “What the fuck? Why is everybody so mad at me?”

Bill Gurley:  That’s right. I think it’s a complete myth. I think it’s a myth that most employers want to drive down costs. The easy thing for them to pick off is apparently premature births and heart attacks can account for like 40% of their bill for a self-insured employer, so they will do things to try and preempt those two events, because they’re so large. But generally driving down costs if it means sacrificing employee satisfaction, they will not do it.

There’s a large number of people in the general populace that think employers are going to drive down costs, the self-insured ones, and there’s a ton of entrepreneur that think it, and from my conversations with these benefits providers,is a myth.

Ezra Klein:  And one thing I think is interesting there, too, is that you would also assume that employers would want to get out of this market. You just talked about how reluctant some of these negotiators are, but in health policy consistently what you hear people say, and it’s Lucy and the football every time, the reason employers ultimately … They may not want to be in the market, just like they may not want to pay high costs, but what they really don’t want to do is piss off their employees. And pulling out of the market and not giving them insurance anymore pisses them off.

Bill Gurley:  Oh, absolutely. If you were to ask them a different question, which is what if the government mandated all employers get out of the business, would you prefer that? They would all say yes, every one of them.

Ezra Klein:  So I’m going to disagree with you here.

Bill Gurley:  Okay.

Ezra Klein:  They could do that. Look, the Chamber of Commerce could lobby for single payer. They don’t do that. The NFIB could lobby for a single payer. There was a couple years ago the Wyden-Bennett bill, which really did a version of that and employers were against it. This is why I say, “This is the Lucy and football of healthcare policy.”

Bill Gurley:  That’s presenting the argument a very specific way where you’re forcing them to opt into something else instead of just opting out. Based on the conversations I’ve had with these people, or even CEOs might be a better way to say it, if we snapped our fingers and in America the employer was no longer part of the healthcare system, would you be okay with that? I think they would all say yes.

Ezra Klein:  But why don’t they … If you’ve had these conversations, if employers were pushing for what we have in every other country, which is a system the government runs and employers aren’t part of, we would have had that system a long time ago. Do they say why they don’t, then, say to their representative, “Hey, quietly, go work with Bernie on that Medicare for All thing.”

Bill Gurley:  Fair enough. I haven’t gone that deep. I just haven’t met a single one of them that finds it to be awesome to be in this role.

Ezra Klein:  I definitely think it’s not awesome. Okay, so you worked on this. You have the employer problem, what else?

Bill Gurley:  There’s other things, like people think carriers want to drive down costs and I haven’t seen a ton of proof of that either because that involves ruffling feathers, you know? It involves upsetting one of these large hospital care systems if you start pushing narrow networks that they’re not in. They make a percentage of the overall pie, so as long as the pie is growing as a percentage of GDP, it’s a pretty good place. So I don’t think they have much incentive either, so there’s a lot of entrepreneurs saying, “Oh, I’m going to help the carrier bring down costs,” or “I’m going to help the employer bring down costs,” and I don’t think the incentives really exist.

Then there’s weird stuff like the thing that kind of is just most shocking to me that I think most of … I’d be surprised if most of your listeners have ever even heard of and may not even believe when I say it, is in 2009 as part of the Reinvestment Act, our government made the decision to pay $20 billion to doctors to implement software. It’s just fascinating, especially from a Silicon Valley perspective. Would anyone ever do that? It’s so radical. We were going to pay people, who are clearly closer to the top 1% than anything else, money, and it’s $44k each, to implement software. It’s crazy.

Ezra Klein:  You’re talking here about electronic health records.

Bill Gurley:  Yes. Well, first of all, why do you need to pay them or why do you think you need to pay them? Well, part of the reason is there aren’t enough market forces to demand that they implement them in the first place. Every other … You don’t have to pay Cisco to put an ERP system in. They have to do it to be competitive.

Ezra Klein:  And it still didn’t work. We actually … So my colleague and I, Sarah Kliff, interviewed President Obama as one of his last interviews about healthcare and we asked him what were his regrets, what did not work? And one of the things he named was EHR adoption had not been what they had hoped, despite the fact that they spent a lot of money on it.

Bill Gurley:  The only reason I can believe that it happened is because the only executive on his advisory committee was the CEO of Epic Software, the largest EHR vendor out there. If you go back and study which company benefited the most from that program, it was Epic. That’s the only reason I can believe that it happened, but it makes no sense whatsoever.

If you were going to pay somebody to put in software, what would you worry about? You’d worry about that maybe they don’t use it. So they then paid, on top of the $44k, $17k or something like that if you could verify that you’re using this software that they already paid you to buy. As I learned it, I was just agape. My mouth was like … I can’t believe someone tried this. It’s prone to failure by design. But if you’re out there trying to compete in that market … Back at that time, all the software vendors had tons of content, web pages, YouTube videos, about what? How to qualify for your payment? So rather than working on software, they were developing web pages and probably holding events, teaching you how you can collect this free money.

Ezra Klein:  It’s notable that during this period, Google had a big push to do online health records that would be owned by the individual, but hopefully could integrate with medical practitioners, and eventually they closed that whole thing down. It’s one of the things that Google made a big deal about and really tried. I actually played around with that system. It was not a bad system from my perspective. And it totally failed.

Bill Gurley:  One of the things as you go deeper on EHR, which I looked at, one of the problems you have is this large hospital systems growing and taking up smaller providers. Because if you’re a startup and you want to compete in EHR, you’re much more likely to break into small companies than to big ones, and the small ones are going away, so that’s a problem.

The second thing is, if you talk … In my limited conversations with doctors, the majority of the features they’re worried about are the things that get them paid, so how well a system does billing, how well a system helps with collections. Those are the features they care about the most. Google probably brought a very different mentality to the table and it’s not what people are looking for. And this is my whole point about how the system is just designed and designed and designed to kind of grow and to get bigger on top of itself.

Ezra Klein:  So one of the things I thought was interesting when we talked a bit previously was that one of the things that made you optimistic that there might be change in the market, an opening in the market, was actually the Affordable Care Act.

Bill Gurley:  A feature of it, yeah. There were two features of it that I was most excited by. One of them was high deductible plans, which ironically is a feature that I think was not well disclosed and that consumers hated when they realized that it was real, but that’s a different issue. High deductible plans, and then the other one I really liked, which I don’t think will ever see the light of day, is the Cadillac tax. The reason I like the Cadillac tax is because it was the one feature that could start to push employers somewhat out of the system, but that one appears dead. You might know more than me.

Ezra Klein:  Yeah, it doesn’t look like it’s in good shape, but the high deductible plans part is interesting, because that really did happen, is happening. As you say, I do not think that feature was widely disclosed. I know many Republicans who say they oppose Obamacare because it stops high deductible plans from being out there. I often ask them, “You can have a $6,000 deductible in Obamacare, exactly how high do you want the deductible to go?” But the reputation of the bill is that it is pushing against high deductible plans when, in fact, while it does increase benefits that do need to be covered, it’s allowed for quite high deductible and, for that reason, also pushed toward very narrow networks.

Bill Gurley:  Yeah, narrow networks and high deductibles, which I think actually is the first thing I’ve seen that leads towards competition. Obviously when someone has a high deductible plan, until they hit that deductible amount, they’re spending out of pocket. So for the first time, perhaps, and I state broadly, that person’s heading out into the market as a consumer, which is not something they’ve done before. They’re spending out of their own pocket and they’re making a decision as a consumer. I think that that is causing very carefully on the margin some really interesting things to happen.

Ezra Klein:  So here to me is the meat of this discussion. It is the thing that I’ve been thinking about the most listening to the Obamacare debate, listening to the replacement of Obamacare debate, talking to you. As you say, Obamacare created these high deductible plans, these narrow network plans. Those plans did, in some cases, hold premiums further down, at least until recently, they had been estimated to be, and people hate those plans. They hate them. They do not want to have healthcare that is that exposed to the market.

The thing that I think is a real challenge here for particularly folks who are looking to make this a more consumer-driven system is that if we have learned anything from Obamacare, it’s that what people seem to want is just peace of mind. They don’t want high deductibles. They don’t want to be out there shopping in this way. They want to know that if they get sick, somebody’s going to cover it the way they do in Medicare, which people like, the way they do in Medicaid, which people like. You get all of this reporting about folks who are in the high deductible plans being mad at the people who are poorer than them who get Medicaid.

To me, the lesson of this has been … I was not a huge high deductible plans guy at any point, but the lesson of this has been it is going to be very hard to foist this on the public, then Republicans came and said, “The problem with Obamacare is these plans have overly high deductibles and we’re going to bring them down.” Donald Trump said, “We’re going to bring them down.” That’s not what their plan does, but when you have both parties now saying, “The problem with Obamacare is the deductibles are too high,” that to me says something about the plan.

The reason I think this is important is there is this statistic that sticks in my head, it’s from the Federal Reserve actually, that about 46% of Americans say they do not have enough money to cover a $400 emergency expense, 400 bucks. So when you’ve got half the people in that position and health is so scary, that level of financial instability mixed with high deductible plans, that’s a very tough mix, the kind of thing that eventually is going to get people in the streets and say, “Hey, you’ve got to give me some relief from this. I need to not be so afraid all the time.”

Bill Gurley:  Let me try and separate two things. There are questions of policy and certainly if you ask people what they want, that list could grow infinitely, right? They’ll take everything they can get. If you ask, “Would you like more?” you’re always going to get an answer of, “Yes.” But let’s separate that for a second from the point I’m making, which is this hopefully not temporary, but maybe temporary, move to high deductible plans is driving change in the marketplace that is resulting in better care for consumers, from my point of view.

I’ll go into that for a second. One of the places where high deductible plans are the highest is the state of Texas. In Dallas in particular, I happen to know, urgent care facilities are popping up left and right. These facilities have way more focus on the consumer and more entrepreneurialism than any general practitioner ever had. So there’s a pediatric care facility that’s open from 4:00 p.m. to midnight. Now, no doctor in our current system that I’ve ever been aware of has decided, “Oh, I’m serving children. They’re in school. We have parents where both parents work, maybe I should shift my hours to 4:00 to midnight.” That doesn’t happen in our current healthcare system. That happened in this system, though, because someone wanted to differentiate themselves from the next guy and consumers are paying out of pocket and making a choice. There is more parking spaces, it’s easier to pull up. They care about net promoter score, they measure the wait time in their facility, they ask for a review after the fact. And satisfaction levels are fantastic.

I’d just separate the point you were making because the point I’m making is that a move towards creating shoppers is creating better care on primary care, just in terms of how we treat the consumer, and the consumers are opting into that and finding it interesting and effective.

Ezra Klein:  Let me ask you about why the high deductible plan is necessary for that particular kind of innovation. So backing up on how healthcare is financed, let’s say you got a plan with basically no deductible, so you’ve got first dollar coverage. Let’s just say something, a stylized Medicare plan. You still have to choose where you go and the places that are going to make money are the places that attract people to come to their office, right? I feel like the argument for the high deductible is it will make things that are cheaper, which I think is true. You deregulate airlines and you get cheaper airlines. You get Southwest, you get Spirit Air, you get stuff that in many ways is much more bare bones, but when people are paying their own money, they’re willing to make that trade offset.

The kind of better care, higher quality care, you’re talking about, the thing where you go to the primary care facility and it’s beautiful in there, and it opens at 4:00 p.m. and it goes to 11:00 p.m., even in a place where you’re not exposed to the cost, but they just need to attract the bulk of the people who have an insurance care, that feels to me like a perfectly reasonable system to incentivize that kind of pro consumer innovation.

Bill Gurley:  I would argue we haven’t seen that. These things that I’m seeing for the first time, and as a venture investor get excited about because it’s the kind of disruption that could lead to fundability, it is in my mind just happening here for the first time. So I don’t think our system has done that. I do think there’s a middle ground, though, to this, which is flexible spending accounts are first dollar is not out of your pocket, but you do care about the choice you’re making. Because you have a piece of the economics in the system. That’s a middle ground approach that could achieve both of what you want and what I’m talking about.

Ezra Klein:  It’s interesting, because that’s actually a very good bridge to … You brought up Singapore at the beginning of our conversation and I have a big obsession with the Singaporean healthcare system, too. Do you want to talk about how that system works from your perspective?

Bill Gurley:  The first thing I would say is this: The fascinating thing about Singapore is that they spend about 4% of GDP on healthcare and we spend somewhere between 17% and 18%. Based on the simplest measures that people calculate care, life expectancy, those kind of things, there’s no demonstrable difference, and people can certainly argue on the margin. My biggest … Like, my brain just can’t stop from wanting to go, “Oh, my God, they’re at 1/4 the cost, 1/4!” That is so dramatically eye opening that our first reaction should be, “We should study this until we can’t stay awake anymore, because it is so dramatically different in terms of cost relative to output that they must be doing something we don’t understand.”

Instead, when you make this argument to people about Singapore, lots of people go, “Oh, but it’s a small island Asian country,” they start saying, “But, you shouldn’t look at it,” and I’m like, “Really? Someone’s doing something for 1/4 the cost we are and their reaction is to come up with reasons why you shouldn’t care about it?” We should just go nuts. We should be like, “Oh, my God, we should try everything they’re doing. Every single thing.”

Ezra Klein:  Also, to just build on that point a little bit, every Western European nation and also Canada and also Israel gets about … It’s about half of what we pay, it’s not as cheap as Singapore, but if we only managed to cut our costs in half, that would also be a big advance.

Bill Gurley:  Absolutely.

Ezra Klein:  So the idea that there is nowhere we can look for some kind of answer here seems pretty … It’s always struck me as quite bizarre.

Bill Gurley:  Yeah. So there are multiple parts to the Singapore system as you and I have discussed before. The one that I find most fascinating is they make everyone a payer. The way they do that … Except there is a social safety net at the bottom, but for the majority of the populace, depending on your income level, they will provide help from the government on a sliding scale percentage. So if you’re extremely well to do, you pay 80% of your bill, and if you’re down towards the lower income, you pay 20% of your bill, but everyone’s in the market shopping. I find that fascinating and I’m not as … And maybe this comes from the Goldhill camp, but I’m not surprised that that leads to better execution and cheaper care.

Ezra Klein:  So I’m going to give a little bit of a quick Singapore overview for folks who aren’t as read in on it, and if anybody would like to learn a lot more about this, they can search my name and Singaporean healthcare system. I’ve got a long explainer about this on Vox.

Singapore is a system that conservatives love. Ross Douthat has called it “the marvel of the wealthy world.” Fox News had this op-ed that if we wanted to replace Obamacare, let’s copy Singapore’s miracle, and what conservatives tend to liken Singapore to is the insurance design. It’s a very unusual system. What they do is they have a forced saving account. So the Singaporean government basically diverts 7% to 9.5% of your wages into a compulsory savings account that you can only use for healthcare and, in fact, only use for the particular healthcare they let you use it for, which is interesting. It’s a little bit like a health savings account mixed with the Social Security payroll tax.

Then they have catastrophic care, again provided by the government. You pay premiums. That’s got a roughly, in our dollars, $1500-ish deductible, and then there’s this meta fund sort of safety net at the very bottom. What conservatives like there is that you’ve got, as you say, Bill, everybody’s a payer. People are paying first dollar care out of their forced savings account, then they’ve got catastrophic care over that. You really have to shop. But the other thing, and this is I think such a key thing that gets forgotten or left out about them, it is otherwise a basically government driven medical system where the government decides pricing.

So what you were saying about the rich paying 80-ish%, the poor paying 20%, that’s not happening through insurance, it’s happening because the government runs the hospitals and it separates them into these different wards and then it prices them based on how much subsidy you’re going to get, depending on your income. Drug companies, they can’t just charge what they want. If they want their drugs to be provided in those wards and if they want it to be eligible for that forced savings dollars, they have to price it at a level of cost effectiveness that the Singaporean government likes.

So what Singapore is doing, which I think is so interesting and is a reminder that there are much more radical fusions of left wing and right wing ideas than people give credit for, is the government is overwhelmingly regulating both supply and prices to keep costs down. But then with those low costs is creating an insurance system where the average Singaporean is quite exposed to the cost and has a reason to shop. If you tried to do that with our level of costs, you would have to make people divert like 20% of their income, because those forced savings accounts are also for your kids, they’re also for your parents, and that would only pay for some of your care.

To me, it’s a reminder that there may be more ways to cut this than people realize. That if the government was able to act as a price negotiator and get prices down, a lot of things would open up in how we design insurance, because people would not be so afraid of financial calamity.

Bill Gurley:  Look, as I said earlier, I think one of the problems is that people that favor one approach vilify all the others and, for me, it’s simply like, “Oh, my God, they’re at 1/4 our cost.” We should just do a mirror copy of the whole thing. I don’t know why you would pick pieces of it. Let’s just copy it. I’m not a policy person, but that’s my policy reaction.

Ezra Klein:  Just control C, control V Singapore?

Bill Gurley:  Yes.

Ezra Klein:  But this goes to something I think is hard for entrepreneurs, hard for the government, hard for anybody on either side of the aisle who wants to change anything, which is that people are very risk averse about their healthcare. They don’t want to change doctors. They don’t want things to change under them. They’re afraid, and rightfully so, right? When I am sick, the main thing I feel is fear, so I’m not saying … I don’t want to say people, I want to say me here. And this I think is actually a particular problem in some ways potentially for Silicon Valley. There’s a culture in Silicon Valley that moves fast and breaks things, right? That’s the old Facebook motto. You have a culture like Uber that sort of bum rushes regulators in ways that allow them to make big gains in territory, but really piss people off.

I think folks are maybe open to that in places like social networks or even ride sharing, but if you tried to do that in healthcare or if the government tries to do that and takes away what people have, promising they’ve got something better, folks get real angry and it only takes one or two bad experiences, one or two people who really have something bad happen to them, to end that real quick.

Bill Gurley:  One thing I would say to that is I don’t think there are any opportunities to disrupt healthcare in that type of way, simply because the amount, the shear force of inertia, the amount of regulation that exists, there’s no way for someone to rush in and disrupt at that level with kind of hackneyed solutions. I don’t think it could happen. It does pose the question, though, that if your assertion is right, that aversion to change is so high that we’re just never going to get a shot on goal, then we might be stuck. You might be able to do this podcast 80 years from now and have all the same discussions.

Ezra Klein:  I kind of worry I will be able to. Hopefully I’ll be well enough to do this podcast in 80 years, and that would be a real triumph of the healthcare system.

Bill Gurley:  Let me make this assertion, which I think is, especially if we’re on an 80-year time window, I think China is going to be a really interesting thing to watch. I have this theory that democracy and capitalism will destroy one another if you give them enough time, and our most regulated industries are ones that are least open to disruption, so healthcare, finance, telecom, and what ends up happening is the incumbents end up writing the rules and you kind of bog down. China and Singapore, by the way, are nondemocratic capitalistic societies, and so it’s actually easier for those types of governments to make wholesale change than it is in our case, so they can make the types of systems that we’ve been talking about, or they could decide to mirror Singapore or whatever, and everybody just kind of has to take it.

But the other thing you have in China, so you haven’t had much of a healthcare system and so you don’t have this regulatory framework that makes it very difficult for new entrants or disruptive entrants, but you’ve got really successful and talented entrepreneurs. I think you’re going to see some failure like you talk about because there is less regulation, but I think you’re also going to see some amazing innovation.

I am friends with a couple of venture capitalists over there and things like second opinion via telemedicine, those things are happening there way faster than here. There’s a whole network of specialists in the big cities that do second opinion over telemedicine with doctors that are in the rural areas for the customer, which is a practice that doesn’t even exist here. People say, “Why isn’t telemedicine or email more active here?” Well, they don’t know how to bill for it and so it doesn’t happen. Doctors don’t do it because they can’t bill for it. Eventually figure out how to bill for it, and then you’ll have a telemedicine with your doctor and 80% of the time, you won’t need to go into their building anymore. But that’s going to happen slower here than there, precisely because of where we find ourselves. So that will be interesting to watch.

Ezra Klein:  Tell me more about your theory that democracy and capitalism will eat each other. Why will that happen?

Bill Gurley:  Well, industries get more regulated and incumbents write the regulation. Let’s take one of the healthcare things, let’s take HIPAA. Every single consumer thinks HIPAA was written to protect them, from my perspective. HIPAA is an extremely dangerous policy in a day and age where we have the communication tools that we do. I’ve got a friend who’s an ER doctor and if he’s in the middle of an emergency situation and he’s got a friend that has the answer and he texts him and asks for help, that’s a HIPAA violation, like $50,000 fine. Now my friend does it anyway and if your mother were on that table, you’d want him to do it anyway. But you’re not supposed to do it … And, by the way, they have HIPAA audits. So there are people that are paid to provide HIPAA audits where they come around and test your systems, so all this HIPAA this and HIPAA that and, by the way, when Britney Spears’ data got disclosed, HIPAA audits tripled at this guy’s hospital, so it’s nice to know that Britney caused such care.

When you want to build a new system that heightens communication so maybe you can get the better answers faster, you run into HIPAA front, left, and center. Epic, who’s the largest healthcare system tool, EMR company out there, is notorious for not integrating with people. I’m certain one of the reasons they claim they don’t have to is because they hold up HIPAA and say, “No, can’t do it.” These regulations people think are written to protect themselves are written to protect the system. This isn’t an argument that all regulation is bad, it’s just how it matures over time.

Ezra Klein:  Yeah, I certainly think there’s something to that.

Bill Gurley:  I’ll give you a non-healthcare version real quick.

Ezra Klein:  Yeah, please.

Bill Gurley:  I was a backer of a company called Tropos that we sold, but they provided tools to let a city bathe their city in Wi-Fi. Obviously you think about why a mayor might find that to be interesting, to bathe the city in Wi-Fi. We found tons of mayors that were interested in doing this, and I think it’s simple to make the argument that a mayor or city might choose to build a port or a railroad or a highway, why wouldn’t they also build a digital highway if they wanted to for their constituency? But, over the years, the telco companies and the cable companies have written law after law after law to make it illegal for that mayor to do that.

If those laws didn’t exist when we would get a mayor excited about it, an AT&T lobbyist would show up in the smallest of places and start lobbying against this from the government. Our ability to provide competitive Wi-Fi services through a city, which seems to be, based on that narrative I just used, seems to be something they should be able to do, is blocked by the broader government through rules that were written by the incumbents.

Ezra Klein:  So then given these facts, and I agree with you, that healthcare is a place of many, many, many rules and many of them at this point outdated or not helpful to new entrants, and I think we said earlier that this is not an area ripe for overwhelming disruption. What are the layers of healthcare that you think are open to entrepreneurs? What are the spaces in the sector that you think people listening or who are already out there could profitably begin to hack away at in a useful way?

Bill Gurley:  Well one thing that happens, and I want to talk about it because we’ve actually made some bets, so I’m not 100% a pessimist here. I do believe that there are opportunities. One of the things that happens is a lot of startups get pulled into the system and that’s unfortunate, because it turns out that when you’ve got this thing that’s 18% of GDP and you start following the money flows, you enter a market in one place with a very altruistic notion that I’m going to change things, and ask things morph, it turns out you’re actually just helping the system get bigger and helping people collect, if you will, as a leach against the system.

There was a startup that I met with that was in the messaging space and I’m fascinated by messaging just because I think if there were more communication among everybody, it should lead to a more efficient world. I started asking, “What is it you’re providing? What type of messaging and how much do you get paid for it?” And they said, “We get paid $50 a message.” I’m like, “$50 a message? are like a penny. How could you get paid for that? What are you doing?” And he was connecting these rehabilitation centers with hospitals and it turns out the way our insurance has evolved, a hospital can move someone to a rehabilitation center and keep charging. And I said, “Well, what do you tell them?” And he goes, “When 30 days are up.” And I said, “Why 30 days?” And he said, “Well, that’s the limit to which you can get reimbursement against this type of facility.” This entrepreneur I’m sure started out thinking I’m going to make the system better, but all they were doing was helping the hospital maximize what they could charge. And I think that kind of stuff happens all the time.

Anne from 23andMe told me that she went through a similar journey when she decided to go into healthcare and she just noticed startup after startup that entered the system hoping to help, but when you follow the money flows and start trying to get paid, you find you’re actually making things worse. I don’t want to fund anything like that, just because … And it’s not like I have some kind of moral high ground, that’s not interesting to me, to make it worse. I want to hopefully be part of something that makes it better.

Ezra Klein:  So then to go back to the question, what are the layers of this that you think are open to being made better?

Bill Gurley:  This notion that I brought up, which we used the phrase “the consumerization of healthcare,” I think that’s starting to happen. I think consumers have lived through this transformation in other industries. Banks were notoriously open from 9:00 to 3:00. Banker hours is a metaphor that young kids probably won’t even know what it means anymore, right? But it’s because banks used to not have to be competitive with one another and they had rules that didn’t really think about the customer the way a normal business would. I think that trend is starting to change. We’ve made a few bets that relate to that.

One of them is a company called One Medical, which we’ve been an investor in for probably four or five years now, and One Medical is a premises-based healthcare provider. This isn’t a software company, although they have software tools. It is literally like Starbucks. They have to put one of these up. They focused on urban areas, so they’re downtown near your place of work rather than being near your home, they have a 24-hour appointment policy and I think a one-hour email response policy, and people love it. It turns out that it doesn’t take that much convenience to stand out like a sore thumb versus what people have grown to expect.

Ezra Klein:  Let me ask you something about that model really quickly, because I know One Medical well and I actually think they are a fascinating company. That seems to me to be almost the opposite of the high deductible consumerization of medical care. One Medical is you pay more on top of your insurance. They have a lot of people who have employer insurance, including a lot of people I know, you pay more on top of what you’re already paying for insurance to get better service, which is great, right? One should be able to pay more to get more, that’s all fine. But it does not seem to be the folks with the very high deductibles in Obamacare. That doesn’t seem to be where that’s going to lead.

Bill Gurley:  Yeah, and as I said, we made this investment three or four years ago and that was purely a bet that a number of consumers want something more than what they’ve been getting from their healthcare system. So last week we announced an investment in a company called Solve, which is very new. They just kind of took the covers off for the first time, so it’s early, but they’re fitting more to what you’re talking about. They’ve built a network, a marketplace, on top of these urgent care facilities and so this is more like OpenTable or Grubhub or Zillow, and it’s a curated set of these people that are operating with full price transparency and have this desire to kind of be competitive from a consumerization standpoint.

Like I said, they measure wait times, they want you to be able to come in right away. I think of all the bookings that we’ve taken, 80% of them have been within a two-hour window. So no one thinks about seeing their general practitioner unless it’s a complete emergency within a two-hour window, but the majority of people that book through Solve are doing it within two hours. So it is, trying to put this network layer, you can do things like check in ahead of time as opposed to show up and get handed the large clipboard full of papers to fill out because they know you’re going to wait anyway. In this case, you can get that all done up front. So you walk in and get seen and, by the way, after you’re done, you get a communication asking you to review that the actual practitioner wants to see, because they measure NPS scores, which I had talked about in the past.

This is early. That’s operating just in Dallas right now, but I anticipate that there’s going to be enough competitive providers who are willing to operate with that type of expectation that we’ll be able to build this nationwide.

Ezra Klein:  Let me ask you something about the broader thinking around both of these, which we were talking about a little bit earlier around the Houston primary care example, too, which is I don’t understand really why any of these were not viable businesses in a non-high deductible care model. These are all adding convenience by, I assume, taking a little bit of cut, so in some way like raising price at least a little bit, which is not necessarily a bad thing in this case, but adding convenience onto the system we already have. I think it opens this question of why the system just hasn’t had at least more of a demand around quality than it’s had.

I expect what’s going to happen with the high deductible world is people are going to accept less convenience and less quality. Again, it’s going to go in this direction of, if the regulators allow it and this is certainly what Republicans want to do by accelerating the deregulation of very, very narrow network, very, very high deductible plans that don’t cover that much and so on and so forth because they’re just too expensive. But this stuff, people have always had the ability to pay a bit more to get something a little bit better and it’s been a system resistant to it in large part because people seem very resistant to change and very set in their habits. They go to the same doctor for a long time, etc. What do you think here is changing? It feels like it may be something different than what we’re talking about.

Bill Gurley:  It’s totally plausible that they’re disconnected, that the time has come and these tools, by the way, because if you look forward, this telemedicine piece for these type of providers is going to become a big piece of it, because there’s just more convenience for the consumer that’s possible. Maybe it was just the time is right. I happen to believe that having high deductible plans out there or even people that opt out that are paying the penalty, they’re shoppers, too, put more people into the frame of mind where they’re making those choices.

Look, there’s also narrow networks and there’s many Kaiser clones popping up. There’s one called Scott & White in Texas that’s really impressive. It’s their own narrow network and they’re actually literally listing plans on the exchange. So they’re a wholesale carrier provider all in one package, and they are competitive from a convenience perspective, too. Maybe we’re just seeing a whole bunch of alternatives pop up, some of which are driven by this consumerization piece and that’s causing choice, and people are opting into it.

Ezra Klein:  Let me give you my theory. I think that some of this, and I think One Medical is a good example of it, is we are getting a culture into a different kind of convenience. You used Open Table and Grubhub, which I know are different than the new thing you funded, but I do think are beginning to habituate consumers to that kind of experience, so people are beginning to both expect it and feel more familiar with it when it comes around.

But the place that I’m curious if you looked into when you were doing your research is you’ve had the Apple Watch and Jawbone and all these different things that are essentially bioinformatics that you wear on you and right now, they’re sort of fun things for the fitness set, right? They’re for people who are pretty healthy already and enjoy tracking their sleep and quantifying their life and all of that. But it’s not too hard to imagine some of these things that are much better at helping folks remember to take their medications, for instance, right? A huge issue is drug adherence, particularly for people who are forgetful or who have mental health issues. Something on the wrist that was really good and simple at making sure they took their medicines, or at least reminding them to do it, could make a big difference.

You could imagine things that, I don’t know the science of this that well, but there are early markers of things like heart attacks and possibly there are things people could wear that would help alert them very early. If you had a very at-risk population, maybe that would help. That feels to me like where the technology might really make a big difference and both drive down costs and drive up quality pretty dramatically. Did you see stuff?

Bill Gurley:  Yeah, there’s a lot of stuff like that. Most of it’s targeted at acute care, so you’ll see startups like that targeted at cardiovascular issues or diabetes or things like that. They all struggle with how do you lean against the American healthcare system? Some of them end up trying to sell these solutions through the self-insured employer, which we already talked about is a kind of really non-optimal way to get out there. Some of them are trying to create the right to bill for a digital solution. It’s very new ground, so if I build an app and a wearable device that if I use, I’ll monitor my diet better and, therefore, I’ll reduce my carbohydrate intake and diabetes will improve, getting our insurance carriers to accept paying for that app or service as a billable thing is non-trivial. And there are startups trying to do that right now.

It’s not the type of bet we’ve made historically, because it’s dependent on your ability to get that acceptance, and I don’t know if that will happen or not. It may happen. We may see digital solutions become billable prescriptions. There are a number of startups trying to make that happen. Even if that technology can be helpful in that way, you still have to figure out a way to get charged in the US healthcare system, which is non-trivial.

Ezra Klein:  Let me then ask you, I’ve taken up enough of your time here, the question we use to close out this podcast, which is what are a couple books on healthcare or anything else that you’ve read that have influenced you that you would recommend to the audience?

Bill Gurley:  As I mentioned, the Catastrophic Care by Goldhill I would read on healthcare. Most of the other books I’ve read recently you’ve already had podcasts with the authors, like Sapiens I read recently, which I really enjoyed. In healthcare, there’s a whole book on the Singapore system you’ve probably read. I haven’t read yet, but I’m interested to read.

Ezra Klein:  Jeremy Lim’s

Bill Gurley:  Is it good?

Ezra Klein:  I think it’s Singapore Myth or Miracle? Yeah, I think it’s excellent.

Bill Gurley:  Yeah.

Ezra Klein:  It’s actually just a good book on healthcare straight up and from a non-American perspective I think really works. I highly recommend that book.

Bill Gurley:  Cool, I’ll read that. And I listen to all of your podcasts on the subject.

Ezra Klein:  Well, thank you. Alright, come on, one book on technology.

Bill Gurley:  There’s a set of books that I recommend startups read and some of them are basic, but there’s a book called Startup by Jerry Kaplan where he had a startup that was in like the tablet space, but it was called Go. It was before all the tablets actually were successful and they had the best investors, the best executives, and it was a colossal failure. What’s most interesting is on the way home every day, he recorded into a microphone and so he had a log of the story that was particular high fidelity and then after it was all over, he wrote a book about it.

To me, it’s the most real startup journey that’s ever been written, and it’s actually more real because it didn’t work. Most of the people in the book have gone on to do other things very successfully, but it was just super eye opening. So that’s one.

Crossing the Chasm for enterprise plays you have to read. Innovator’s Dilemma is probably the most efficient analysis of why startups are able to disrupt. These are books people know about, but entrepreneur should read these things like bibles.

One last one, which a lot of people have been recommending, Phil Knight’s Nike book that he just came out with about a year ago is just fantastic. Unbelievable.

Ezra Klein:  Bill Gurley. Thank you very much.

Bill Gurley:  All right. Take care.

Ezra Klein:  Thank you to Bill for being on the podcast. Thank you to all of you for listening to the podcast. Thank you to my producers, Byrd Pinkerton and Peter Leonard.

 

 

Thinking of Home: Dickinson, Texas


This post is by bgurley from Above the Crowd

For those of you who have moved away from the town where you grew up, the few times that you see your hometown in the national news creates an enormous sense of pride. Over the past few weeks, the town I grew up in, Dickinson, Texas, has been front and center in the national news, but for all the wrong reasons. Dickinson, a small town southeast of Houston on Galveston Bay, has been one of the hardest hit communities by Hurricane Harvey.

I became a resident of Dickinson for the same reason many of my childhood friends did. My father, John, was an early NASA employee, and when Johnson Space Center opened in Clear Lake, he and many of his colleagues made Dickinson their home. It seems like half of the fathers on our street worked at NASA. Gene Kranz, the famous NASA Flight Director is a Dickinsonian. I, along with a handful of others in my class, spent my entire K-12 education in the Dickinson public school system and graduated from Dickinson High School in 1984. When people ask me “where did you grow up?” or “where are you from?” there is one easy answer — Dickinson.

That said, our family’s strongest tie to Dickinson is the countless hours my mother, Lucia Gurley, spent in service of the town and community over her 38 years as a resident. She currently lives in Marble Falls, but during her time in Dickinson, my mother’s impact on the local community was quite significant. She was a substitute teacher for over 20 years, she volunteered at the local library, she helped raise grants for the public school system, and was a key contributor to Keep Dickinson Beautiful. In 1992, she was recognized nationally for her leadership in the H.O.S.T.S. program, receiving the Betty Scharff Memorial Award, and in 1994 was recognized by the local Chamber of Commerce as Citizen of the Year. Most significantly, she served as a councilwoman on the city council for 11 years, and upon retiring was recognized for her efforts in the local newspaper.

Although it does not appear that either were as devastating as Harvey, our family lived through two difficult storms while we lived in Dickinson. In the summer of 1979 Tropical Storm Claudette dumped 43 inches of rain on the area in a single day. Our house ended up with 2-3 feet of water inside, and as a result I have a small sense of how painful life will be for many of the residents over the next many months. In 1983, the eye of Hurricane Alicia went directly over Dickinson. My mother spent the entire evening at city hall, while my father and I worked in our backyard to keep trees from falling on our roof. Alicia’s damage was more wind than water.

Harvey’s impact has been even more severe. The city estimates that Dickinson received over 50 inches of rain in just a few days. Preliminary damage assessment indicates more than 7,300 homes experienced some level of damage from Hurricane Harvey. And over half of these homes — well over 3,500 — had either major damage or were destroyed, displacing thousands of residents. Almost all of this damage was the result of flooding as Dickinson Bayou backed up due to the storm surge and heavy rains.

In recognition of the immense need in Dickinson, and in honor of my mother’s significant contribution to this community, my wife, Amy, and I have decided to donate one million dollars to the city’s Harvey Relief Fund. There have been many remarkable fundraising efforts as a result of Hurricane Harvey, and we are both moved by the generosity of Les Alexander, JJ Watt, Michael Dell and countless others. Amy and I wanted to ensure that this small and vibrant community of Dickinson also has the resources it needs to rebuild. If anyone else is interested in helping out, you can find the Dickinson Harvey Relief Fund website here: http://www.ci.dickinson.tx.us/626/Donate-to-Dickinson-Harvey-Relief-Fund

Having lived through two of these storms myself, I can confirm what you have already read in the press. Tragedies like these bring out the very best in a community and neighborhood. During the storms our family encountered, we were awestruck by the sheer volume of neighbors helping neighbors. I have already heard many stories of this amazing spirit of community at work in Dickinson once again in reaction to Harvey. The national news covered many heroic acts of rescue during the storm. I have also heard from those on the ground that neighbors are once again lending a hand as the clean up efforts begin. This same spirit will help this great community rebuild and thrive again.

Benchmark’s New General Partner Sarah Tavel


This post is by bgurley from Above the Crowd

The partners at Benchmark are excited to announce that Sarah Tavel has joined the firm as our newest General Partner. We define ourselves by a love for the craft of early stage investing, and Sarah’s career-long desire and commitment to be one of the world’s great venture capitalists make her an ideal addition to the Benchmark team.

About a year ago, we asked our venture partner Scott Belsky who he thought had the greatest potential to become one of the best investors of the next decade. He answered quickly and definitively: Sarah Tavel. We’ve gotten to know Sarah over the last year. While we only very recently revealed our interest in having her join us, our interactions with her over the year amplified our instincts. She especially impressed us with the speed and quality of her thinking around disruptive markets, her ability to influence others with her ideas, and the depth of the relationships she has forged.

Throughout her career, Sarah has shown a remarkable ability to spot new companies and markets, and to develop deep bonds with extraordinary entrepreneurs. Early on, at Bessemer Venture Partners, she helped source and pursue companies as varied as Pinterest and GitHub well before they were broadly understood. Not only did she identify these phenomena before others, she left long-lasting impressions on the founders of both companies. In fact, Ben Silbermann thought so highly of Sarah that he recruited her to Pinterest to lead core parts of the product and business after the Bessemer investment. The experience of helping scale Pinterest through a period of explosive growth is an incredible resource for the founders on whose boards she will serve in the future.

Most recently, Sarah worked as an investing partner at one of the great venture capital firms, Greylock Partners, working with some of the sharpest product minds in the business.

Beyond her impeccable resume, from our earliest interactions Sarah demonstrated an investor mindset that just felt consistent with our own. Our small, focused team approach relies on open debate, advocacy, and working together to support the entrepreneurs we serve. Each partner at Benchmark needs to bring a unique perspective while simultaneously enhancing the overall functioning of the team. It is clear that Sarah will get in front of breakout companies early, challenge our thinking on new markets, help us make sharper decisions, and be an incredible partner for the entrepreneurs we back.

Adding a new partner is an infrequent event for Benchmark. Our structure – now six equal partners – means Sarah joins with the same authority, responsibility and ownership as the current partners. We have the highest conviction Sarah will excel at the complex craft of early stage venture investing and are thrilled to welcome her to the team.

Bill, Eric, Matt, Mitch and Peter

Follow Sarah on Twitter: @sarahtavel

On the Road to Recap:


This post is by bgurley from Above the Crowd

Why the Unicorn Financing Market Just Became Dangerous…For All Involved

In February of last year, Fortune magazine writers Erin Griffith and Dan Primack declared 2015 “The Age of the Unicorns” noting — “Fortune counts more than 80 startups that have been valued at $1 billion or more by venture capitalists.” By January of 2016, that number had ballooned to 229. One key to this population growth has been the remarkable ease of the Unicorn fundraising process: Pick a new valuation well above your last one, put together a presentation deck, solicit offers, and watch the hundreds of million of dollars flow into your bank account. Twelve to eighteen months later, you hit the road and do it again — super simple.

While not obvious on the surface, there has been a fundamental sea-change in the investment community that has made the incremental Unicorn investment a substantially more dangerous and complicated practice. All Unicorn participants — founders, company employees, venture investors and their limited partners (LPs) — are seeing their fortunes put at risk from the very nature of the Unicorn phenomenon itself. The pressures of lofty paper valuations, massive burn rates (and the subsequent need for more cash), and unprecedented low levels of IPOs and M&A, have created a complex and unique circumstance that many Unicorn CEOs and investors are ill-prepared to navigate.

Many have noted that the aggregate shareholder value created by all of the Unicorns will vastly overshadow the losses from the inevitable failed unicorns. This likely truism is driven by the clear success of this generation’s transformational companies (AirBNB, Slack, Snapchat, Uber, etc). While this could provide some sense of comfort, most are not exposed to a Unicorn basket, and there is no index you can buy. Rather, most participants in the ecosystem have exposure to and responsibility for specific company performance, which is exactly why the changing landscape is important to understand.

Perhaps the seminal bubble-popping event was John Carreyrou’s October 16th investigative analysis of Theranos in the Wall Street Journal. John was the first to uncover that just because a company can raise money from a handful of investors at a very high price, it does not guarantee (i) everything is going well at the company, or (ii) those shares are permanently worth the last round valuation. Ironically, Carreyrou is not a Silicon Valley-focused reporter, and the success of the piece served as a wake-up call for other journalists who may have been struck by Unicorn fever. Next came Rolfe Winkler’s deep dive “Highly Valued Startup Zenefits Runs Into Turbulence.” We should expect more of these in the future.

In late 2015, many public technology companies saw a significant retrenchment in their share prices primarily as a result of a reduction in valuation multiples. A high performing, high-growth SAAS company that may have been worth 10 or more times revenue was suddenly worth 4-7 times revenue. The same thing happened to many Internet stocks. These broad-based multiple contractions have an immediate impact on what investors are willing to pay for the more mature private companies.

Late 2015 also brought the arrival of “mutual fund markdowns.” Many Unicorns had taken private fundraising dollars from mutual funds. These mutual funds “mark-to-market” every day, and fund managers are compensated periodically on this performance. As a result, most firms have independent internal groups that periodically analyze valuations. With the public markets down, these groups began writing down Unicorn valuations. Once more, the fantasy began to come apart. The last round is not the permanent price, and being private does not mean you get a free pass on scrutiny.

At the same time, we also started to see an increase in startup failure. In addition to high profile companies like Fab.com, Quirky, Homejoy, and Secret, numerous other VC-backed companies began to shut their doors. There were in fact so many that CB Insights started a list. Layoffs have also become more prevalent. Mixpanel, Jawbone, Twitter, HotelTonight and many others made the tough decision to reduce headcount in an attempt to lower expenses (and presumably burn rate). Many modern entrepreneurs have limited exposure to the notion of failure or layoffs because it has been so long since these things were common in the industry.

By the first quarter of 2016, the late-stage financing market had changed materially. Investors were becoming nervous and were no longer willing to underwrite new Unicorn-level financings at the drop of a hat. Moreover, once high-flying startups began to struggle on the fundraising trail. In Silicon Valley boardrooms, where “growth at all costs” had been the mantra for many years, people began to imagine a world where the cost of capital could rise dramatically, and profits could come back in vogue. Anxiety slowly crept into everyone’s world.

About this same point in time, the journalists that focus specifically on the venture capital industry noted something quite profound. In 1999, record valuations coexisted with record IPOs and shareholder liquidity. 2015 was the exact opposite. Record private Unicorn valuations were offset by increasingly fewer and fewer IPOs. If 1999 was a wet (read liquid) bubble, 2015 was a particularly dry one. Everyone was successful on paper, but in terms of real cash-on-cash returns, there was little to show. In Q1 of 2016 there were zero VC-backed technology IPOs. Less than one year since declaring it the “Age of the Unicorns,” Fortune Magazine was back with a dire warning, “Silicon Valley’s $585 Billion Problem: Good Luck Getting Out.

As we move forward, it is important for all players in the ecosystem to realize that the game has changed. Equally important, each player must understand how the new rules apply to them specifically. We will start by highlighting several emotional biases that can irrationally impact everyone’s decision making process. Next we will highlight the new player in the ecosystem that is poised to take advantage of these aforementioned changes and emerging biases. Lastly, we will then walk through each player in the ecosystem and what they should consider as they navigate this brave new world.

Emotional Biases

When academicians study markets, one common assumption is that the market participants will act in a rational way. But what if the participants are in a position that leads them to non-optimal and potentially irrational behavior? Many biases bring irrationality to the Unicorn fundraising environment:

  1. Founder/CEO — Many Unicorn founders and CEOs have never experienced a difficult fundraising environment — they have only known success. Also, they have a strong belief that any sign of weakness (such as a down round) will have a catastrophic impact on their culture, hiring process, and ability to retain employees. Their own ego is also a factor – will a down round signal weakness?  It might be hard to imagine the level of fear and anxiety that can creep into a formerly confident mind in a transitional moment like this.
  2. Investors — The typical 2016 VC investor is also subject to emotional bias. They are likely sitting on amazing paper-based gains that have already been recorded as a success by their own investors — the LPs. Anything that hints of a down round brings questions about the success metrics that have already been “booked.” Furthermore, an abundance of such write-downs could impede their ability to raise their next fund. So an anxious investor might have multiple incentives to protect appearances — to do anything they can to prevent a down round.
  3. Anyone that has already “banked” their return — Whether you are a founder, executive, seed investor, VC, or late stage investor, there is a chance that you have taken the last round valuation and multiplied it by your ownership position and told yourself that you are worth this amount. It is simple human nature that if you have done this mental exercise and convinced yourself of a foregone conclusion, you will have difficulty rationalizing a down round investment.
  4. A race for the exits — As fear of downward price movement takes hold, some players in the ecosystem will attempt a brisk and desperate grab at immediate liquidity, placing their own interests at the front of the line. This happens in every market transition, and can create quite a bit of tension between the different constituents in each company. We have already seen examples of founders and management obtaining liquidity in front of investors. And there are also modern examples of investors beating the founders and employees out the door. Obviously, simultaneous liquidity is the most appropriate choice, however, fear of price deterioration as well as lengthened liquidity timing can cause parties on both sides to take a “me first” perspective.

The Sharks Arrive With Dirty Term Sheets

Who are the Sharks?  These are sophisticated and opportunistic investors that instinctively understand the aforementioned biases of the participants and know exactly how to craft investments that can exploit the situation. They lie in wait of these exact situations, and salivate at the opportunity to exercise their advantage.

“Dirty” or structured term sheets are proposed investments where the majority of the economic gains for the investor come not from the headline valuation, but rather through a series of dirty terms that are hidden deeper in the document. This allows the Shark to meet the valuation “ask” of the entrepreneur and VC board member, all the while knowing that they will make excellent returns, even at exits that are far below the cover valuation.

Examples of dirty terms include guaranteed IPO returns, ratchets, PIK Dividends, series-based M&A vetoes, and superior preferences or liquidity rights. The typical Silicon Valley term sheet does not include such terms. The reason these terms can produce returns by themselves is that they set the stage for a rejiggering of the capitalization table at some point in the future. This is why the founder and their VC BOD member can still hold onto the illusion that everything is fine. The adjustment does not happen now, it will happen later.

Dirty term sheets are a massive problem for two reasons. One is that they “unpack” or “explode” at some point in the future. You can no longer simply look at the cap table and estimate your return. Once you have accepted a dirty offering, the payout at each potential future valuation requires a complex analysis, where the return for the Shark is calculated first, and then the remains are shared by everyone else. The second reason they are a massive problem is that their complexity will render future financings all but impossible.

Any investor asked to follow a dirty offering will look at the complexity of the previous offering and likely opt out. This severely heightens the risk of either running out of money or a complete recapitalization that wipes out previous shareholders (founder, employees, and investors alike). So, while it may seem innocuous to take such a round, and while it will solve your short term emotional biases and concerns, you may be putting your whole company in a much riskier position without even knowing it.

Some later-stage investors may be tempted to become Sharks themselves and start including structured terms into their own term sheets. Following through and succeeding at such a strategy will require these investors to truly embrace being a Shark. They will need to be comfortable knowing that they are adverse to and in conflict with the founders, employees, and other investors on the capitalization chart. And they will need to be content knowing that they can win while others lose. This is not for the faint of heart, and certainly is not consistent with the typical investor behavior of the past several years.

Let us now take a deeper dive into what this new fundraising environment means for each participant in the ecosystem.

Entrepreneurs/Founders/CEOs

Today’s Unicorn entrepreneur has been trained in an environment that may look radically different from what lies ahead. Here is the historic perspective. Money has been easy to raise. The market favors growth over profits. Competition also has access to capital. So, raise as much as you can as fast as you can, and be super-ambitious. Take as much market share as you can.

Never in the history of venture capital have early stage startups had access to so much capital. Back in 1999, if a company raised $30mm before an IPO, that was considered a large historic raise. Today, private companies have raised 10x that amount and more. And consequently, the burn rates are 10x larger than they were back then. All of which creates a voraciously hungry Unicorn. One that needs lots and lots of capital (if it is to stay on the current trajectory).

For the first time, perhaps in their lives, these entrepreneurs may face a situation where they cannot raise a clean incremental financing at a flat to up round. This is uncharted territory. There are a few alternatives:

  1. The first option available to many Unicorns today is a dirty term sheet. As discussed above, these terms can cleverly fool the inexperienced operator, because they are able to “meet the ask” with respect to cover valuation, and the accepting founder does not realize the carnage that will come down the road. The only reason one would accept such a deal is to maintain valuation appearances that simply do not matter. Taking a terms-laden deal is like starting the clock on a time bomb. Your only option is to hit the IPO window as fast as possible (Note: Box and Square were able to thread this needle successfully), otherwise, the terms will eat you alive. The main problem is that you will never raise another private round again, as no new investor will want to live on top of the termy round. So you will be stuck negotiating with the lender that already proved they were smarter than you.
  2. Take a clean round at a lower valuation. This will seem like a massive failure to many modern entrepreneurs, but they should quickly adjust their thinking. Reed Hastings at Netflix raised money in a high profile down round as a public CEO. Every single public CEO has had days where the stock price falls — it is common and accepted. The only thing you are protecting is image and ego and in the long run they absolutely do not matter. You should be more concerned about the long-term valuation of your shares, and minimizing the chance that you have the whole thing taken away from you. Terms are the true Godzilla that should scare you to death. A down round is nothing. Get over it and move on. Option #2 is way better than option #1.
  3. Buckle down and do whatever it takes to get cash-flow positive with your current cash balance. This might be the most foreign of all the choices, as your board of directors has been advising you to do the exact opposite for the past four years. You have been told to be “bold” and “ambitious” and that there is no better time to grab market share. Despite this, the only way to be completely in control of your own destiny is to remove the need for incremental capital raises altogether. Achieving profitability is the most liberating action a startup can accomplish. Now you make your own decisions. It will also minimize future dilution. Gavin Baker, a high-profile portfolio manager at Fidelity has a message for Unicorn CEOs: “Generate $1 of free cash flow, and then you can invest everything else in growth and stay at $1 in free cash flow for years.  I get that you want to grow and I want you to grow, but let’s internally finance that growth by spending gross margin dollars rather than new dilutive dollars of equity.  Ultimately, internally financing growth is the only way to control your own destiny rather than being at the mercy of the capital markets.”
  4. Go public. In the long run, the very best way for founders to look after their own ownership as well as that of their employees is to IPO. Until an IPO, common shares sit behind preferred shares. Most preferred shares have different types of control functions and most of them have a senior preference over common. If you really want to liberate your own common shares and those of your employees, then you want to convert the preferred to common and remove both the control and the liquidation preference over your shares. Many founders have been erroneously advised that IPOs are bad things and that the way to success is to “stay private longer.” Not only is an IPO better for your company (see Mark Zuckerberg and Marc Benioff on this subject), but an IPO is the best way to ensure the long-term value of your (and your employees’) shares.

It is worth noting that stock prices go up and stock prices go down. There is not a single high-profile public company that has been able to avoid time periods where their shares underperformed. Amazon went from $106 to $6 as a public company. Salesforce went from $16 to $6 and stayed below $10 for many months. Netflix went from $38 to $8 in six months. Remember Facebook’s first six months as a public company?

If you cannot handle a down valuation you should seriously consider abandoning the CEO position. Being a great leader means leading in good times as well as tough times. Taking a dirty deal is jeopardizing the future of your company, solely because you are afraid to lead through difficult news.

Employees

The explicit details of the capital structure of a company are typically obfuscated from the average employee. You know you work for a Unicorn, and you know you have some common shares. You might also know what percentage you own. And unfortunately, you may assume that the product of your Unicorn valuation and your percentage ownership is what you are worth. Of course, for that to be true, you need to reach a liquidity event (IPO or M&A) at or above the last round valuation with no incremental dilution from new rounds. But guess what: M&A is scarce (no large company wants to pay these prices or absorb these burn rates), and many founders have been told IPOs are bad. So how will you ever get liquid?

For the most part, employees are in the exact same position as founders (above), with the exception that they don’t participate in the decision tree outlined above in 1-4. That said, they should be asking the exact same questions of management:  Can we get to break-even on the money we have?  Do we need to raise more money?  If so, can we do it on clean terms (vs. dirty)?  Employees should want to know if the founder/CEO would/did take a dirty deal, because common is at the most risk in such a situation. And then you should want to know if your leader is anti-IPO. If your CEO/founder will take a dirty round, and is also anti-IPO the chance that you will ever see liquidity for you shares anywhere near what you think they are worth is very, very low. You should probably move on to another company.

INVESTORS

Disclosure: It should be noted that the author of the article and his investment firm reside in this category.

For the most part, early investors in Unicorns are in the same position as founders and employees. This is because these companies have raised so much capital that the early investor is no longer a substantial portion of the voting rights or the liquidation preference stack. As a result, most of their interests are aligned with the common, and key decisions about return and liquidity are the same as for the founder. This investor will also be wary of the dirty term sheet which has the ability to wrestle away control of the entire company. This investor will also have sufficient angst about the difference between paper return and real return, and the lack of overall liquidity in the market. Or at least they should.

The one exception to this is the late-stage investor or the deep-pocketed investor who may represent a substantial part of the overall money raised. This particular type of investor may have protected their ownership through the use of active pro-rata or super pro-rata investing. They may have even encouraged the aggressive “spend-to-win” mentality knowing that they can keep writing checks. They have been acting like a loose-aggressive player at a poker table.

There are two forces which have began to slow down this type of investor. First, as failure has begun to arrive on the scene, these investors have suffered some really big write-offs. These spectacular losses result in a lack of confidence not only for the investor, but more importantly for their LPs. The second problem is that for many of these investors, a single holding can become too large relative to the overall fund. They basically cannot afford to expose themselves to any more risk in a particular name. They use euphemisms to describe having over-eaten such as “fully allocated” or “at capacity.”

This form of big investor indigestion has created a really bizarre and unprecedented activity in the Unicorn world. High-profile investors, who are already armed with plenty of capital, have resorted to hitting the phone banks to solicit others to pile in behind them in their names. The voracious Unicorns need even more capital than these big-boys can afford. Ironically, if you look at the big historic wins of this investor class, there is no record of sending out Evites to other investors. But now they “need” others, which should signal risk to all parties involved. More on this later.

Investors also have to worry about raising their next fund, which can lead to unusual behavior that is independent of each individual company’s situation.  Do you support the dirty term sheet because this allows you to keep your paper-mark and not spook your investors?  Even though you know this may be bad for the company in the long run?  Do you feel the need to raise more capital quickly before the prices erode further and bring down your IRR? Do you feel the need to have more money to keep feeding the cash hungry companies you have already funded?

LIMITED PARTNERS (LPS)

LPs are the large pools of capital, such as endowments and foundations, that invest in VC firms, hedge funds and the like. They are the real capital that make the system work. LPs evaluate the performance of the different investors in the ecosystem and make decisions about whether to fund their next effort or not. It’s a difficult job because the feedback cycles are so long — especially when it comes to investing in illiquid assets like startups (and Unicorns).

Another big challenge for LPs is that they are asked to measure the performance of these illiquid assets even though doing so is quite difficult and may not be indicative of future real cash returns. In this case, many LPs have incorporated the high performance of Unicorn valuations into their overall results which has created very strong performance gains for the venture capital category. In a sense they have already “banked” the gains. The problem obviously is that the lack of any material liquidity in the market combined with the recent correction creates a risk that they may not see the actual cash returns for the paper gains they already booked.

Furthermore, as mentioned earlier, they may face increased solicitation from VC firms who want to accelerate their fundraising process in the middle of this highly anxious environment. A recent WSJ article, “Venture-Capital Firms Draw a Rush of New Money,” highlights that VC firms are raising new funds from LPs at the highest rate in 15 years, even though cash liquidity is sitting at a seven-year low. A few sentences from the article are worth republishing here:

  • In recent years venture firms have written bigger checks and encouraged companies to spend to battle for market supremacy.  That left some venture firms short of cash, requiring them to raise money sooner than in years past to continue reaping fees and making new investments.
  • Some venture capitalists say the fundraising spike is timed to ensure that paper gains on startup investments still look attractive.
  • Cash distributions are what matter at the end of the day, but big paper gains still make for good fundraising pitches.

In addition to these issues, there has also been an increase in “inside rounds” where investors write new checks into companies where they are already investors, avoiding the “market check” that might have resulted in a potentially down valuation. This activity, which has an obvious conflict of interest, makes the LP’s job of judging VC performance even more difficult.

Against this difficult backdrop, many firms are asking their LPs to make new accelerated commitments to their next fund, exactly when evaluation is most difficult and anxiety may be at a cyclical peak. Moreover, deep down most LPs know that performance in the VC sector is counter cyclical to the amount of money raised by VCs. If you over-fund the industry, aggregate returns fall. Writing huge checks to bloated multibillion dollar VC funds could easily exacerbate the problems that already exist.

One response from the LP community might be to demand commitments from new funds that prohibit inside-led rounds and cross-fund investing. This can help to ensure that new capital is not put to use in an attempt to save previous investment decisions — an activity known as “throwing good money after bad.”

If this were not enough, some LPs are also being solicited to participate in SPVs (Special Purpose Vehicles), frequently from the very funds they have backed. As discussed earlier, some investors have reached a stage when they are overcommitted to a particular company in a particular fund (“at capacity”). Yet these investors want to keep providing capital to their Unicorns and support a growth-over-profits attitude. So they create a one-time special purpose investment vehicle (while greedily asking for even more carry). And the SPV has the added risk that is has no portfolio diversification or “look-back” feature to provide downside protection.

Obviously the LPs can just say “no” to participating in the SPV (even though they may feel the pressure of obligation from the fund). This is likely the smart move. First, someone is asking you to write a check at the exact time everyone else is overcommitted.  Hey, come help us out, we are drowning over here!  Second, you already have ample exposure to this exact company, through your original investment. Lastly, it is quite unlikely that a historical study of peak-cycle SPV participation shows good returns.

ALL PREVIOUSLY UNTAPPED FINANCIAL SOURCES (FAMILY OFFICES, SOVEREIGN WEALTH FUNDS, ETC)

If you have a large pool of money and you haven’t been approached to invest in a Unicorn, it’s simply because people do not know where to find you. There are three types of people who are likely now approaching you, all of whom you should engage with quite carefully:

  1. SPV promoters – As mentioned in the section on LPs, investors have also broadened their SPV marketing more broadly to family offices and other pools of capital. The pitches typically involve phrases such as “you are invited to” or “we will provide access to” an opportunity to invest. This “you are so lucky to have this opportunity” pitch is eerily Madoffian. And remember, this solicitation is coming from investors who actually have money, but already know they are overcommitted.
  2. Brokers and 3rd-tier investment banks promoting the sale of secondary shares in Unicorn companies – If you ask any large family office, they will tell you they are being bombarded with calls and emails offering secondary positions in Unicorn companies. Often with teasers such as “20-40% discount to last round price.”
  3. Incremental Unicorn round – You might also be called on simply to pump more capital into a standard Unicorn round. With many investors “at capacity” due to the historic amounts of capital already raised, some companies are looking under any and every rock they can for more dollars.

One of the shocking realities that is present in many of these “investment opportunities” is a relative absence of pertinent financial information. One would think that these opportunities which are often sold as “pre-IPO” rounds would have something close to the data you might see in an S-1. But often, the financial information is quite limited. And when it is included, it may be presented in a way that is inconsistent with GAAP standards. As an example, most Unicorn CEOs still have no idea that discounts, coupons, and subsidies are contra-revenue.

If an audit is included, it might have massive “qualifications” where the auditor lists all the reasons that this particular audit may not comply with GAAP standards and that things could change materially if they dig in deeper. Investors need to really open their eyes to the fact that these are not IPOs. The companies have not been scrubbed in the same way, and the numbers they are looking at on a PowerPoint deck are potentially erroneous. Here is a recommendation: If you are about to write a multimillion dollar check for an incremental Unicorn investment, ask to speak to the auditor. Find out exactly how much scrutiny has been applied.

New potential investors might also be surprised how few Unicorn executives truly understand their core unit economics. One easy way to spot these pretenders is that they obsessively focus on high level “gross merchandise value” or “multi-year forward bookings” and try to talk past things like true net revenue, gross margin, or operating profitability. They will even claim to be “unit profitable” when all they have really done is stopped being gross margin negative. These companies will one day need real earnings and real profits, and if the company does not proactively address this, you should not be giving them millions of dollars in late stage financings.

Perhaps the biggest mistake untapped investors will make is assuming that because there are branded investors already in the company, that the new investment opportunity must be of high quality. They use the reputation of the other investors as a proxy for due diligence. There are multiple problems with this shortcut. First, these investors are “pot committed.” They invested a long time ago, and without your money their investment is “at risk.” Second, as discussed, they are already full and nervous. They didn’t call you before when they built their reputation.  Why are they friendly now?

The main message for investors who are just now being approached is the following: it’s not the second inning or even the sixth, it’s the fourteenth inning in a five-hour baseball game. You are not being invited to a special dance, you are being approached because you are the lender of last resort. And because of how we meandered to this place in time, parting with your dollars now would be an extremely risky move. Caveat emptor.

SEC Visits Silicon Valley

A few weeks ago, on March 31, 2016, the Chair of the SEC made a trip to Silicon Valley and gave a speech at an event at Stanford Law School. For those that are participating in Unicorn investing or for those considering investing in Unicorns, it would be a good idea to read the entirety of her presentation (which can be found here). Bloomberg’s interpretation of her presentation was that “Silicon Valley Needs To Corral Its Unicorns.

Chair White seems quite aware of the issues and pressures that have an ability to distort the Unicorn fundraising process:

Nearly all venture valuations are highly subjective.  But, one must wonder whether the publicity and pressure to achieve the unicorn benchmark is analogous to that felt by public companies to meet projections they make to the market with the attendant risk of financial reporting problems.

And then she sends a message to all former and future investors regarding the need for increased due diligence:

As I will discuss, the risk of distortion and inaccuracy is amplified because start-up companies, even quite mature ones, often have far less robust internal controls and governance procedures than most public companies.  Vigilance by private companies about the accuracy of their financial results and other disclosures is thus especially critical.

It would be quite unfortunate if the fundraising behavior of the Unicorn herd led to increased SEC involvement and rules with respect to private venture-backed startups. But if those involved believe that “not being public” also means “not being responsible,” we will quickly find ourselves in that exact place. We will have deservedly invited more scrutiny.

Mo Money Mo Problems

Perhaps the biggest lapse in judgment for all of those involved is the assumption that if we can just raise “one more round” everything will be fine. Founders have come to believe that more money is better, and the fluidity of the recent funding environment has led many to believe that heroic fundraising is a competitive advantage. Ironically, the exact opposite is true. The very best entrepreneurs are relatively advantaged in times of scarce capital. They can raise money in any environment. Loose capital allows the less qualified to participate in each market. This less qualified player brings more reckless execution which drags even the best entrepreneur onto an especially sloppy playing field. This threatens returns for all involved.

The reason we are all in this mess is because of the excessive amounts of capital that have poured into the VC-backed startup market. This glut of capital has led to (1) record high burn rates, likely 5-10x those of the 1999 timeframe, (2) most companies operating far, far away from profitability, (3) excessively intense competition driven by access to said capital, (4) delayed or non-existent liquidity for employees and investors, and (5) the aforementioned solicitous fundraising practices. More money will not solve any of these problems — it will only contribute to them. The healthiest thing that could possibly happen is a dramatic increase in the real cost of capital and a return to an appreciation for sound business execution.

On the Road to Recap:


This post is by bgurley from Above the Crowd

Why the Unicorn Financing Market Just Became Dangerous…For All Involved

In February of last year, Fortune magazine writers Erin Griffith and Dan Primack declared 2015 “The Age of the Unicorns” noting — “Fortune counts more than 80 startups that have been valued at $1 billion or more by venture capitalists.” By January of 2016, that number had ballooned to 229. One key to this population growth has been the remarkable ease of the Unicorn fundraising process: Pick a new valuation well above your last one, put together a presentation deck, solicit offers, and watch the hundreds of million of dollars flow into your bank account. Twelve to eighteen months later, you hit the road and do it again — super simple.

While not obvious on the surface, there has been a fundamental sea-change in the investment community that has made the incremental Unicorn investment a substantially more dangerous and complicated practice. All Unicorn participants — founders, company employees, venture investors and their limited partners (LPs) — are seeing their fortunes put at risk from the very nature of the Unicorn phenomenon itself. The pressures of lofty paper valuations, massive burn rates (and the subsequent need for more cash), and unprecedented low levels of IPOs and M&A, have created a complex and unique circumstance that many Unicorn CEOs and investors are ill-prepared to navigate.

Many have noted that the aggregate shareholder value created by all of the Unicorns will vastly overshadow the losses from the inevitable failed unicorns. This likely truism is driven by the clear success of this generation’s transformational companies (AirBNB, Slack, Snapchat, Uber, etc). While this could provide some sense of comfort, most are not exposed to a Unicorn basket, and there is no index you can buy. Rather, most participants in the ecosystem have exposure to and responsibility for specific company performance, which is exactly why the changing landscape is important to understand.

Perhaps the seminal bubble-popping event was John Carreyrou’s October 16th investigative analysis of Theranos in the Wall Street Journal. John was the first to uncover that just because a company can raise money from a handful of investors at a very high price, it does not guarantee (i) everything is going well at the company, or (ii) those shares are permanently worth the last round valuation. Ironically, Carreyrou is not a Silicon Valley-focused reporter, and the success of the piece served as a wake-up call for other journalists who may have been struck by Unicorn fever. Next came Rolfe Winkler’s deep dive “Highly Valued Startup Zenefits Runs Into Turbulence.” We should expect more of these in the future.

In late 2015, many public technology companies saw a significant retrenchment in their share prices primarily as a result of a reduction in valuation multiples. A high performing, high-growth SAAS company that may have been worth 10 or more times revenue was suddenly worth 4-7 times revenue. The same thing happened to many Internet stocks. These broad-based multiple contractions have an immediate impact on what investors are willing to pay for the more mature private companies.

Late 2015 also brought the arrival of “mutual fund markdowns.” Many Unicorns had taken private fundraising dollars from mutual funds. These mutual funds “mark-to-market” every day, and fund managers are compensated periodically on this performance. As a result, most firms have independent internal groups that periodically analyze valuations. With the public markets down, these groups began writing down Unicorn valuations. Once more, the fantasy began to come apart. The last round is not the permanent price, and being private does not mean you get a free pass on scrutiny.

At the same time, we also started to see an increase in startup failure. In addition to high profile companies like Fab.com, Quirky, Homejoy, and Secret, numerous other VC-backed companies began to shut their doors. There were in fact so many that CB Insights started a list. Layoffs have also become more prevalent. Mixpanel, Jawbone, Twitter, HotelTonight and many others made the tough decision to reduce headcount in an attempt to lower expenses (and presumably burn rate). Many modern entrepreneurs have limited exposure to the notion of failure or layoffs because it has been so long since these things were common in the industry.

By the first quarter of 2016, the late-stage financing market had changed materially. Investors were becoming nervous and were no longer willing to underwrite new Unicorn-level financings at the drop of a hat. Moreover, once high-flying startups began to struggle on the fundraising trail. In Silicon Valley boardrooms, where “growth at all costs” had been the mantra for many years, people began to imagine a world where the cost of capital could rise dramatically, and profits could come back in vogue. Anxiety slowly crept into everyone’s world.

About this same point in time, the journalists that focus specifically on the venture capital industry noted something quite profound. In 1999, record valuations coexisted with record IPOs and shareholder liquidity. 2015 was the exact opposite. Record private Unicorn valuations were offset by increasingly fewer and fewer IPOs. If 1999 was a wet (read liquid) bubble, 2015 was a particularly dry one. Everyone was successful on paper, but in terms of real cash-on-cash returns, there was little to show. In Q1 of 2016 there were zero VC-backed technology IPOs. Less than one year since declaring it the “Age of the Unicorns,” Fortune Magazine was back with a dire warning, “Silicon Valley’s $585 Billion Problem: Good Luck Getting Out.

As we move forward, it is important for all players in the ecosystem to realize that the game has changed. Equally important, each player must understand how the new rules apply to them specifically. We will start by highlighting several emotional biases that can irrationally impact everyone’s decision making process. Next we will highlight the new player in the ecosystem that is poised to take advantage of these aforementioned changes and emerging biases. Lastly, we will then walk through each player in the ecosystem and what they should consider as they navigate this brave new world.

Emotional Biases

When academicians study markets, one common assumption is that the market participants will act in a rational way. But what if the participants are in a position that leads them to non-optimal and potentially irrational behavior? Many biases bring irrationality to the Unicorn fundraising environment:

  1. Founder/CEO — Many Unicorn founders and CEOs have never experienced a difficult fundraising environment — they have only known success. Also, they have a strong belief that any sign of weakness (such as a down round) will have a catastrophic impact on their culture, hiring process, and ability to retain employees. Their own ego is also a factor – will a down round signal weakness?  It might be hard to imagine the level of fear and anxiety that can creep into a formerly confident mind in a transitional moment like this.
  2. Investors — The typical 2016 VC investor is also subject to emotional bias. They are likely sitting on amazing paper-based gains that have already been recorded as a success by their own investors — the LPs. Anything that hints of a down round brings questions about the success metrics that have already been “booked.” Furthermore, an abundance of such write-downs could impede their ability to raise their next fund. So an anxious investor might have multiple incentives to protect appearances — to do anything they can to prevent a down round.
  3. Anyone that has already “banked” their return — Whether you are a founder, executive, seed investor, VC, or late stage investor, there is a chance that you have taken the last round valuation and multiplied it by your ownership position and told yourself that you are worth this amount. It is simple human nature that if you have done this mental exercise and convinced yourself of a foregone conclusion, you will have difficulty rationalizing a down round investment.
  4. A race for the exits — As fear of downward price movement takes hold, some players in the ecosystem will attempt a brisk and desperate grab at immediate liquidity, placing their own interests at the front of the line. This happens in every market transition, and can create quite a bit of tension between the different constituents in each company. We have already seen examples of founders and management obtaining liquidity in front of investors. And there are also modern examples of investors beating the founders and employees out the door. Obviously, simultaneous liquidity is the most appropriate choice, however, fear of price deterioration as well as lengthened liquidity timing can cause parties on both sides to take a “me first” perspective.

The Sharks Arrive With Dirty Term Sheets

Who are the Sharks?  These are sophisticated and opportunistic investors that instinctively understand the aforementioned biases of the participants and know exactly how to craft investments that can exploit the situation. They lie in wait of these exact situations, and salivate at the opportunity to exercise their advantage.

“Dirty” or structured term sheets are proposed investments where the majority of the economic gains for the investor come not from the headline valuation, but rather through a series of dirty terms that are hidden deeper in the document. This allows the Shark to meet the valuation “ask” of the entrepreneur and VC board member, all the while knowing that they will make excellent returns, even at exits that are far below the cover valuation.

Examples of dirty terms include guaranteed IPO returns, ratchets, PIK Dividends, series-based M&A vetoes, and superior preferences or liquidity rights. The typical Silicon Valley term sheet does not include such terms. The reason these terms can produce returns by themselves is that they set the stage for a rejiggering of the capitalization table at some point in the future. This is why the founder and their VC BOD member can still hold onto the illusion that everything is fine. The adjustment does not happen now, it will happen later.

Dirty term sheets are a massive problem for two reasons. One is that they “unpack” or “explode” at some point in the future. You can no longer simply look at the cap table and estimate your return. Once you have accepted a dirty offering, the payout at each potential future valuation requires a complex analysis, where the return for the Shark is calculated first, and then the remains are shared by everyone else. The second reason they are a massive problem is that their complexity will render future financings all but impossible.

Any investor asked to follow a dirty offering will look at the complexity of the previous offering and likely opt out. This severely heightens the risk of either running out of money or a complete recapitalization that wipes out previous shareholders (founder, employees, and investors alike). So, while it may seem innocuous to take such a round, and while it will solve your short term emotional biases and concerns, you may be putting your whole company in a much riskier position without even knowing it.

Some later-stage investors may be tempted to become Sharks themselves and start including structured terms into their own term sheets. Following through and succeeding at such a strategy will require these investors to truly embrace being a Shark. They will need to be comfortable knowing that they are adverse to and in conflict with the founders, employees, and other investors on the capitalization chart. And they will need to be content knowing that they can win while others lose. This is not for the faint of heart, and certainly is not consistent with the typical investor behavior of the past several years.

Let us now take a deeper dive into what this new fundraising environment means for each participant in the ecosystem.

Entrepreneurs/Founders/CEOs

Today’s Unicorn entrepreneur has been trained in an environment that may look radically different from what lies ahead. Here is the historic perspective. Money has been easy to raise. The market favors growth over profits. Competition also has access to capital. So, raise as much as you can as fast as you can, and be super-ambitious. Take as much market share as you can.

Never in the history of venture capital have early stage startups had access to so much capital. Back in 1999, if a company raised $30mm before an IPO, that was considered a large historic raise. Today, private companies have raised 10x that amount and more. And consequently, the burn rates are 10x larger than they were back then. All of which creates a voraciously hungry Unicorn. One that needs lots and lots of capital (if it is to stay on the current trajectory).

For the first time, perhaps in their lives, these entrepreneurs may face a situation where they cannot raise a clean incremental financing at a flat to up round. This is uncharted territory. There are a few alternatives:

  1. The first option available to many Unicorns today is a dirty term sheet. As discussed above, these terms can cleverly fool the inexperienced operator, because they are able to “meet the ask” with respect to cover valuation, and the accepting founder does not realize the carnage that will come down the road. The only reason one would accept such a deal is to maintain valuation appearances that simply do not matter. Taking a terms-laden deal is like starting the clock on a time bomb. Your only option is to hit the IPO window as fast as possible (Note: Box and Square were able to thread this needle successfully), otherwise, the terms will eat you alive. The main problem is that you will never raise another private round again, as no new investor will want to live on top of the termy round. So you will be stuck negotiating with the lender that already proved they were smarter than you.
  2. Take a clean round at a lower valuation. This will seem like a massive failure to many modern entrepreneurs, but they should quickly adjust their thinking. Reed Hastings at Netflix raised money in a high profile down round as a public CEO. Every single public CEO has had days where the stock price falls — it is common and accepted. The only thing you are protecting is image and ego and in the long run they absolutely do not matter. You should be more concerned about the long-term valuation of your shares, and minimizing the chance that you have the whole thing taken away from you. Terms are the true Godzilla that should scare you to death. A down round is nothing. Get over it and move on. Option #2 is way better than option #1.
  3. Buckle down and do whatever it takes to get cash-flow positive with your current cash balance. This might be the most foreign of all the choices, as your board of directors has been advising you to do the exact opposite for the past four years. You have been told to be “bold” and “ambitious” and that there is no better time to grab market share. Despite this, the only way to be completely in control of your own destiny is to remove the need for incremental capital raises altogether. Achieving profitability is the most liberating action a startup can accomplish. Now you make your own decisions. It will also minimize future dilution. Gavin Baker, a high-profile portfolio manager at Fidelity has a message for Unicorn CEOs: “Generate $1 of free cash flow, and then you can invest everything else in growth and stay at $1 in free cash flow for years.  I get that you want to grow and I want you to grow, but let’s internally finance that growth by spending gross margin dollars rather than new dilutive dollars of equity.  Ultimately, internally financing growth is the only way to control your own destiny rather than being at the mercy of the capital markets.”
  4. Go public. In the long run, the very best way for founders to look after their own ownership as well as that of their employees is to IPO. Until an IPO, common shares sit behind preferred shares. Most preferred shares have different types of control functions and most of them have a senior preference over common. If you really want to liberate your own common shares and those of your employees, then you want to convert the preferred to common and remove both the control and the liquidation preference over your shares. Many founders have been erroneously advised that IPOs are bad things and that the way to success is to “stay private longer.” Not only is an IPO better for your company (see Mark Zuckerberg and Marc Benioff on this subject), but an IPO is the best way to ensure the long-term value of your (and your employees’) shares.

It is worth noting that stock prices go up and stock prices go down. There is not a single high-profile public company that has been able to avoid time periods where their shares underperformed. Amazon went from $106 to $6 as a public company. Salesforce went from $16 to $6 and stayed below $10 for many months. Netflix went from $38 to $8 in six months. Remember Facebook’s first six months as a public company?

If you cannot handle a down valuation you should seriously consider abandoning the CEO position. Being a great leader means leading in good times as well as tough times. Taking a dirty deal is jeopardizing the future of your company, solely because you are afraid to lead through difficult news.

Employees

The explicit details of the capital structure of a company are typically obfuscated from the average employee. You know you work for a Unicorn, and you know you have some common shares. You might also know what percentage you own. And unfortunately, you may assume that the product of your Unicorn valuation and your percentage ownership is what you are worth. Of course, for that to be true, you need to reach a liquidity event (IPO or M&A) at or above the last round valuation with no incremental dilution from new rounds. But guess what: M&A is scarce (no large company wants to pay these prices or absorb these burn rates), and many founders have been told IPOs are bad. So how will you ever get liquid?

For the most part, employees are in the exact same position as founders (above), with the exception that they don’t participate in the decision tree outlined above in 1-4. That said, they should be asking the exact same questions of management:  Can we get to break-even on the money we have?  Do we need to raise more money?  If so, can we do it on clean terms (vs. dirty)?  Employees should want to know if the founder/CEO would/did take a dirty deal, because common is at the most risk in such a situation. And then you should want to know if your leader is anti-IPO. If your CEO/founder will take a dirty round, and is also anti-IPO the chance that you will ever see liquidity for you shares anywhere near what you think they are worth is very, very low. You should probably move on to another company.

INVESTORS

Disclosure: It should be noted that the author of the article and his investment firm reside in this category.

For the most part, early investors in Unicorns are in the same position as founders and employees. This is because these companies have raised so much capital that the early investor is no longer a substantial portion of the voting rights or the liquidation preference stack. As a result, most of their interests are aligned with the common, and key decisions about return and liquidity are the same as for the founder. This investor will also be wary of the dirty term sheet which has the ability to wrestle away control of the entire company. This investor will also have sufficient angst about the difference between paper return and real return, and the lack of overall liquidity in the market. Or at least they should.

The one exception to this is the late-stage investor or the deep-pocketed investor who may represent a substantial part of the overall money raised. This particular type of investor may have protected their ownership through the use of active pro-rata or super pro-rata investing. They may have even encouraged the aggressive “spend-to-win” mentality knowing that they can keep writing checks. They have been acting like a loose-aggressive player at a poker table.

There are two forces which have began to slow down this type of investor. First, as failure has begun to arrive on the scene, these investors have suffered some really big write-offs. These spectacular losses result in a lack of confidence not only for the investor, but more importantly for their LPs. The second problem is that for many of these investors, a single holding can become too large relative to the overall fund. They basically cannot afford to expose themselves to any more risk in a particular name. They use euphemisms to describe having over-eaten such as “fully allocated” or “at capacity.”

This form of big investor indigestion has created a really bizarre and unprecedented activity in the Unicorn world. High-profile investors, who are already armed with plenty of capital, have resorted to hitting the phone banks to solicit others to pile in behind them in their names. The voracious Unicorns need even more capital than these big-boys can afford. Ironically, if you look at the big historic wins of this investor class, there is no record of sending out Evites to other investors. But now they “need” others, which should signal risk to all parties involved. More on this later.

Investors also have to worry about raising their next fund, which can lead to unusual behavior that is independent of each individual company’s situation.  Do you support the dirty term sheet because this allows you to keep your paper-mark and not spook your investors?  Even though you know this may be bad for the company in the long run?  Do you feel the need to raise more capital quickly before the prices erode further and bring down your IRR? Do you feel the need to have more money to keep feeding the cash hungry companies you have already funded?

LIMITED PARTNERS (LPS)

LPs are the large pools of capital, such as endowments and foundations, that invest in VC firms, hedge funds and the like. They are the real capital that make the system work. LPs evaluate the performance of the different investors in the ecosystem and make decisions about whether to fund their next effort or not. It’s a difficult job because the feedback cycles are so long — especially when it comes to investing in illiquid assets like startups (and Unicorns).

Another big challenge for LPs is that they are asked to measure the performance of these illiquid assets even though doing so is quite difficult and may not be indicative of future real cash returns. In this case, many LPs have incorporated the high performance of Unicorn valuations into their overall results which has created very strong performance gains for the venture capital category. In a sense they have already “banked” the gains. The problem obviously is that the lack of any material liquidity in the market combined with the recent correction creates a risk that they may not see the actual cash returns for the paper gains they already booked.

Furthermore, as mentioned earlier, they may face increased solicitation from VC firms who want to accelerate their fundraising process in the middle of this highly anxious environment. A recent WSJ article, “Venture-Capital Firms Draw a Rush of New Money,” highlights that VC firms are raising new funds from LPs at the highest rate in 15 years, even though cash liquidity is sitting at a seven-year low. A few sentences from the article are worth republishing here:

  • In recent years venture firms have written bigger checks and encouraged companies to spend to battle for market supremacy.  That left some venture firms short of cash, requiring them to raise money sooner than in years past to continue reaping fees and making new investments.
  • Some venture capitalists say the fundraising spike is timed to ensure that paper gains on startup investments still look attractive.
  • Cash distributions are what matter at the end of the day, but big paper gains still make for good fundraising pitches.

In addition to these issues, there has also been an increase in “inside rounds” where investors write new checks into companies where they are already investors, avoiding the “market check” that might have resulted in a potentially down valuation. This activity, which has an obvious conflict of interest, makes the LP’s job of judging VC performance even more difficult.

Against this difficult backdrop, many firms are asking their LPs to make new accelerated commitments to their next fund, exactly when evaluation is most difficult and anxiety may be at a cyclical peak. Moreover, deep down most LPs know that performance in the VC sector is counter cyclical to the amount of money raised by VCs. If you over-fund the industry, aggregate returns fall. Writing huge checks to bloated multibillion dollar VC funds could easily exacerbate the problems that already exist.

One response from the LP community might be to demand commitments from new funds that prohibit inside-led rounds and cross-fund investing. This can help to ensure that new capital is not put to use in an attempt to save previous investment decisions — an activity known as “throwing good money after bad.”

If this were not enough, some LPs are also being solicited to participate in SPVs (Special Purpose Vehicles), frequently from the very funds they have backed. As discussed earlier, some investors have reached a stage when they are overcommitted to a particular company in a particular fund (“at capacity”). Yet these investors want to keep providing capital to their Unicorns and support a growth-over-profits attitude. So they create a one-time special purpose investment vehicle (while greedily asking for even more carry). And the SPV has the added risk that is has no portfolio diversification or “look-back” feature to provide downside protection.

Obviously the LPs can just say “no” to participating in the SPV (even though they may feel the pressure of obligation from the fund). This is likely the smart move. First, someone is asking you to write a check at the exact time everyone else is overcommitted.  Hey, come help us out, we are drowning over here!  Second, you already have ample exposure to this exact company, through your original investment. Lastly, it is quite unlikely that a historical study of peak-cycle SPV participation shows good returns.

ALL PREVIOUSLY UNTAPPED FINANCIAL SOURCES (FAMILY OFFICES, SOVEREIGN WEALTH FUNDS, ETC)

If you have a large pool of money and you haven’t been approached to invest in a Unicorn, it’s simply because people do not know where to find you. There are three types of people who are likely now approaching you, all of whom you should engage with quite carefully:

  1. SPV promoters – As mentioned in the section on LPs, investors have also broadened their SPV marketing more broadly to family offices and other pools of capital. The pitches typically involve phrases such as “you are invited to” or “we will provide access to” an opportunity to invest. This “you are so lucky to have this opportunity” pitch is eerily Madoffian. And remember, this solicitation is coming from investors who actually have money, but already know they are overcommitted.
  2. Brokers and 3rd-tier investment banks promoting the sale of secondary shares in Unicorn companies – If you ask any large family office, they will tell you they are being bombarded with calls and emails offering secondary positions in Unicorn companies. Often with teasers such as “20-40% discount to last round price.”
  3. Incremental Unicorn round – You might also be called on simply to pump more capital into a standard Unicorn round. With many investors “at capacity” due to the historic amounts of capital already raised, some companies are looking under any and every rock they can for more dollars.

One of the shocking realities that is present in many of these “investment opportunities” is a relative absence of pertinent financial information. One would think that these opportunities which are often sold as “pre-IPO” rounds would have something close to the data you might see in an S-1. But often, the financial information is quite limited. And when it is included, it may be presented in a way that is inconsistent with GAAP standards. As an example, most Unicorn CEOs still have no idea that discounts, coupons, and subsidies are contra-revenue.

If an audit is included, it might have massive “qualifications” where the auditor lists all the reasons that this particular audit may not comply with GAAP standards and that things could change materially if they dig in deeper. Investors need to really open their eyes to the fact that these are not IPOs. The companies have not been scrubbed in the same way, and the numbers they are looking at on a PowerPoint deck are potentially erroneous. Here is a recommendation: If you are about to write a multimillion dollar check for an incremental Unicorn investment, ask to speak to the auditor. Find out exactly how much scrutiny has been applied.

New potential investors might also be surprised how few Unicorn executives truly understand their core unit economics. One easy way to spot these pretenders is that they obsessively focus on high level “gross merchandise value” or “multi-year forward bookings” and try to talk past things like true net revenue, gross margin, or operating profitability. They will even claim to be “unit profitable” when all they have really done is stopped being gross margin negative. These companies will one day need real earnings and real profits, and if the company does not proactively address this, you should not be giving them millions of dollars in late stage financings.

Perhaps the biggest mistake untapped investors will make is assuming that because there are branded investors already in the company, that the new investment opportunity must be of high quality. They use the reputation of the other investors as a proxy for due diligence. There are multiple problems with this shortcut. First, these investors are “pot committed.” They invested a long time ago, and without your money their investment is “at risk.” Second, as discussed, they are already full and nervous. They didn’t call you before when they built their reputation.  Why are they friendly now?

The main message for investors who are just now being approached is the following: it’s not the second inning or even the sixth, it’s the fourteenth inning in a five-hour baseball game. You are not being invited to a special dance, you are being approached because you are the lender of last resort. And because of how we meandered to this place in time, parting with your dollars now would be an extremely risky move. Caveat emptor.

SEC Visits Silicon Valley

A few weeks ago, on March 31, 2016, the Chair of the SEC made a trip to Silicon Valley and gave a speech at an event at Stanford Law School. For those that are participating in Unicorn investing or for those considering investing in Unicorns, it would be a good idea to read the entirety of her presentation (which can be found here). Bloomberg’s interpretation of her presentation was that “Silicon Valley Needs To Corral Its Unicorns.

Chair White seems quite aware of the issues and pressures that have an ability to distort the Unicorn fundraising process:

Nearly all venture valuations are highly subjective.  But, one must wonder whether the publicity and pressure to achieve the unicorn benchmark is analogous to that felt by public companies to meet projections they make to the market with the attendant risk of financial reporting problems.

And then she sends a message to all former and future investors regarding the need for increased due diligence:

As I will discuss, the risk of distortion and inaccuracy is amplified because start-up companies, even quite mature ones, often have far less robust internal controls and governance procedures than most public companies.  Vigilance by private companies about the accuracy of their financial results and other disclosures is thus especially critical.

It would be quite unfortunate if the fundraising behavior of the Unicorn herd led to increased SEC involvement and rules with respect to private venture-backed startups. But if those involved believe that “not being public” also means “not being responsible,” we will quickly find ourselves in that exact place. We will have deservedly invited more scrutiny.

Mo Money Mo Problems

Perhaps the biggest lapse in judgment for all of those involved is the assumption that if we can just raise “one more round” everything will be fine. Founders have come to believe that more money is better, and the fluidity of the recent funding environment has led many to believe that heroic fundraising is a competitive advantage. Ironically, the exact opposite is true. The very best entrepreneurs are relatively advantaged in times of scarce capital. They can raise money in any environment. Loose capital allows the less qualified to participate in each market. This less qualified player brings more reckless execution which drags even the best entrepreneur onto an especially sloppy playing field. This threatens returns for all involved.

The reason we are all in this mess is because of the excessive amounts of capital that have poured into the VC-backed startup market. This glut of capital has led to (1) record high burn rates, likely 5-10x those of the 1999 timeframe, (2) most companies operating far, far away from profitability, (3) excessively intense competition driven by access to said capital, (4) delayed or non-existent liquidity for employees and investors, and (5) the aforementioned solicitous fundraising practices. More money will not solve any of these problems — it will only contribute to them. The healthiest thing that could possibly happen is a dramatic increase in the real cost of capital and a return to an appreciation for sound business execution.

In Defense of the Deck


This post is by bgurley from Above the Crowd

My partners and I have noticed an interesting trend over the past few years: an increase in the number of entrepreneurs who prefer to pitch us without the use of a presentation deck. On one hand, this is totally understandable. Many believe that PowerPoint decks are emblematic of the type of bureaucracy disparaged in Dilbert cartoons. Others want to appear “casual” and “conversational” and view the presentation as overly formal. But, going deck-less can be a risky move, and here is why. Investors are not solely evaluating your company’s story. They are also evaluating your ability to convey that story. Efficiently communicating your strategy, business model, and competitive differentiation is required for many critical things you will do as a company.bezos 2

Can you raise money without a standard slide presentation? Sure. Can you have a great investor meeting that is purely conversation? Absolutely. But it is important to separate the possible from the optimal. If you are the next Google and everyone knows that you are in the driver’s seat, you should certainly do as you please. But if you are one of the thousands and thousands of startups that merely want to have an optimal fund raising process, I highly recommend that you develop a killer presentation.

benioffHere are six reasons why good presentation decks are impactful:

  1. Importance of Narrative – Last year I was turned on to an amazing book by  Jonathan Gottschall titled The Storytelling Animal. Gottschall explains how storytelling plays a critical role in each and every human’s life. The purpose of a presentation deck is to enable entrepreneurs to effectively tell the story of their business. In many ways it’s like a structured scientific proof. You want to walk the listener through an argument as to why this is going to be an amazing business. The goal is to bring the investor to the VC equivalent of Q.E.D. A well-organized deck will gradually transport the listener to the desired conclusion – “this will be a great investment.” A rambling free-speech conversation is much less likely to achieve this goal.
  2. Controlling the Cadence – When you have a single hour with investors, you want to use your time wisely and ensure that you deliver all your key points. The organized deck helps you control the tempo and guarantee that you make all your arguments, sequentially, in the time allotted. Once again, this is like a structured proof. You want your arguments to build towards a conclusion in a systematic way. For this same reason, you should also avoid jumping around in the deck (another common occurrence, especially from entrepreneurs with decks that are too large). It might seem to make sense to jump to another slide to give the investor an immediate answer, but this takes you off your game and out of the flow you intended. If the question is answered later in the deck, tell the listener you will discuss it later and postpone answering the question.
  3. Numeracy – You will not find a single definition of “entrepreneur” that does not include the word “business.” Startups are businesses, and businesses run on numbers. Even if you are just starting your company it’s useful to have numeric analysis. It may simply be an expense analysis, or a detailed pricing model, or a TAM (total available market) analysis. If you are post launch, it might involve a viral coefficient discussion or a cohort analysis. If you are post-revenue, it should unquestionably include a financial statement and forward forecast. The one thing your presentation should not be is numberless. It’s nearly impossible to convey complex numerical arguments with only words. Charts, graphs, and tables are orders of magnitude more efficient at this task. The best entrepreneurs I have worked with are all intensely focused on the numbers.
  4. Storytelling Never Ends – As CEO you are the company’s number one salesperson and storyteller. You will spend a large portion of your time recruiting. You will raise more money at later stages. You will do business development meetings. You will take meetings with large customers and prospects. You will need to motivate your employees, and you will (hopefully) be invited to speak at important industry conferences. It is highly unlikely you will do all those things without a structured presentation deck. One-off speeches will have less efficiency and impact. As your company’s “storyteller-in-chief,” it is important for you to be great at this technique. And it’s a skill where practice really impacts performance. So you should start practicing as soon as you possibly can. VCs believe that better storytellers make better entrepreneurs.
  5. The Process Itself Is Useful – The process of crafting the story of your company for the first time can be a cathartic experience. As you and your co-founders start to lay out things like positioning, business model and pricing assumptions, market focus, and key recruiting priorities, you will likely find that not everyone is on the same page. Developing a presentation deck gives you a great forum to nail those things down and to ensure that everyone is working with a common purpose. You will also find that some people are more creative than others at cramming the key parts of a presentation into 20-25 slides (don’t do more than 25) and delivering a very persuasive structured story for your company. The first version will not be great. Show it to your internal team, show it to a few outsiders, get feedback, and iterate. It’s a process. If your team is  new to this, I recommend reading Presenting To Win: The Art of Telling Your Story by Jerry Weissman.
  6. Be Like Steve – Take to YouTube and do some searches for the very best entrepreneurial CEOs. Search for ‘Jeff Bezos presentation,’ or ‘Marc Benioff presentation,’ or ‘Elon Musk presentation‘ or ‘Steve Jobs presentation,’ and you will see that they universally use some form of presentation deck to guide their delivery. I have also seen modern day entrepreneurial leaders like Brian Chesky and Travis Kalanick speak at investor conferences, confidently leveraging the power of a deck. If you choose to freestyle without a deck when so many of the greats make it a normal practice, you risk leaving the impression that either (a) you don’t have the skills to produce a killer presentation, or (b) you are simply indifferent to why it is important. Neither is a good impression to leave with investors.
musk

There is one situation where meeting without a presentation deck is warranted. If you have never met the potential investor and are unsure you want to share your data with this individual, then you have a very valid reason not to go through a detailed presentation. In this case, I would suggest that you make it clear up front that you view this as a “get-to-know-you” meeting and that you will not be diving deep on the business at this time. This will avoid having mismatched expectations.
iPad-2-Keynote-by-Steve-JobsIf you are lucky enough to grow your company from Series A to Series B to Series C, and on to hundreds of millions of dollars in revenue and a successful IPO, you will need to tell your company’s story in high-stakes situations over and over and over again. Because of this, venture capitalists place huge positive weight on how good you are at this skill. The great storytellers have an unfair competitive advantage. They are going to recruit better, they will be darlings in the press, they are going to raise money more easily and at higher prices, they are going to close amazing business developer partnerships, and they are going to have a strong and cohesive corporate culture. Perhaps more to the point, they are more likely to deliver a positive investment return.

…Be Like Dave


This post is by bgurley from Above the Crowd

goldie

Like many of those that had the distinct pleasure of knowing Dave “Goldie” Goldberg, I was shocked and in disbelief when I received the tragic news this past Saturday. I first spent time with Dave when he joined us as an EIR at Benchmark back in 2007, and over the years, we had become good friends. I clearly had become quite accustomed to seeing Dave, because when I realized I would not have a chance to hang with him again it hit me like a ton of bricks. Like so many others, I really, really miss him.

For those of you that do not know him as well, you have likely read the numerous articles highlighting what an amazing guy he was. I was particularly moved by Kara Swisher’s “Does Silicon Valley Have a Soul? It Did — as Well as a Heart — in Dave Goldberg” and Adam Lashinsky’s “Remembering Dave Goldberg.” And there were countless others, that all portray Dave as a special human being that uniquely stood out among so many other remarkable people. An outsider might find these comments overly grandiose, or consider them to be a bit of retroactive embellishment. That would be an error. The stories are completely accurate — Dave was really this special.

For me, it all starts with his intelligence. Dave was wicked smart, and what is really cool is that he could care less whether you knew that or not. Over the years, I have had detailed conversations with David about business, politics, sports, music, poker, and many other subjects. He could go deep in so many areas. He was super-even keeled in most of these discussions, not allowing emotion to distract from his perspective. He was also a fiercely independent thinker, and frequently held opinions that cut against the norm. In each case he would back his argument  with data and in most cases would convince others to change their mind. Because of this, I loved chatting with him, particularly about business and Silicon Valley. If we were ever on different pages, I wanted to sort it out right then and there. I never wanted to be executing a plan that cut against his better judgment.

The other thing that stands out for me is that Dave was insanely funny. At first, I just thought he was kind-of funny, but the more time I was able to spend with him, the more I realized this guy was really f***ing funny. One of the funniest guys I have ever known. This was not jocular humor, but quite the opposite; witty creative humor. His intelligence soaked into his jokes the way syrup penetrates a pancake. And his humor was augmented by one of the most spectacular laughs I have ever heard. He could probably get me going with just that smile and that laugh, but the combination of his humor and that laugh was too much. I do not know how many people were able to see this side of him, but if you did you were quite fortunate.

As others have highlighted, he also had a huge heart and a big tent. He had what seemed like inexhaustible time, patience, and advice for an amazingly large number of people. It is quite remarkable how many people in this ecosystem he has touched, and how many of them are positively moved by the experience. Countless people sought his counsel, and he was always generous with his time. Notably, he was an impeccable listener, a tremendously rare skill that eludes many of the brighter stars in our industry (as well as myself). I always felt like Dave understood and respected me, and I would bet there are many hundreds of others that feel the exact same way.

Most importantly, Dave showed us all exactly what being a great human being looks like. In a post this weekend on Facebook, Jason Calacanis succinctly noted “He was a better friend, a better husband, a better father, a better leader, and a better person than all of us — and we knew that.” When I read these words, I thought “Precisely! That was Dave Goldberg!” I had been thinking the exact same thing over the weekend. Dave was better on all these dimensions and we did all know it. But it was never frustrating because Dave’s greatness was not competitive or threatening, it was gentle, inspirational, and egoless. He was the quintessential standard for the notion of leading by example.

This was Dave’s greatest gift to me —  I now know where true north is. I doubt I will ever achieve his lofty aspirational standard on so many of his unique characteristics. But I know which direction to head. I have a target. And as I circumvent my remaining days on this planet, I have no doubt that I will reflect on his high bar, and think about what I can do to be more like Dave.

I am so grateful to have known him.

…Be Like Dave


This post is by bgurley from Above the Crowd

goldie

Like many of those that had the distinct pleasure of knowing Dave “Goldie” Goldberg, I was shocked and in disbelief when I received the tragic news this past Saturday. I first spent time with Dave when he joined us as an EIR at Benchmark back in 2007, and over the years, we had become good friends. I clearly had become quite accustomed to seeing Dave, because when I realized I would not have a chance to hang with him again it hit me like a ton of bricks. Like so many others, I really, really miss him.

For those of you that do not know him as well, you have likely read the numerous articles highlighting what an amazing guy he was. I was particularly moved by Kara Swisher’s “Does Silicon Valley Have a Soul? It Did — as Well as a Heart — in Dave Goldberg” and Adam Lashinsky’s “Remembering Dave Goldberg.” And there were countless others, that all portray Dave as a special human being that uniquely stood out among so many other remarkable people. An outsider might find these comments overly grandiose, or consider them to be a bit of retroactive embellishment. That would be an error. The stories are completely accurate — Dave was really this special.

For me, it all starts with his intelligence. Dave was wicked smart, and what is really cool is that he could care less whether you knew that or not. Over the years, I have had detailed conversations with David about business, politics, sports, music, poker, and many other subjects. He could go deep in so many areas. He was super-even keeled in most of these discussions, not allowing emotion to distract from his perspective. He was also a fiercely independent thinker, and frequently held opinions that cut against the norm. In each case he would back his argument  with data and in most cases would convince others to change their mind. Because of this, I loved chatting with him, particularly about business and Silicon Valley. If we were ever on different pages, I wanted to sort it out right then and there. I never wanted to be executing a plan that cut against his better judgment.

The other thing that stands out for me is that Dave was insanely funny. At first, I just thought he was kind-of funny, but the more time I was able to spend with him, the more I realized this guy was really f***ing funny. One of the funniest guys I have ever known. This was not jocular humor, but quite the opposite; witty creative humor. His intelligence soaked into his jokes the way syrup penetrates a pancake. And his humor was augmented by one of the most spectacular laughs I have ever heard. He could probably get me going with just that smile and that laugh, but the combination of his humor and that laugh was too much. I do not know how many people were able to see this side of him, but if you did you were quite fortunate.

As others have highlighted, he also had a huge heart and a big tent. He had what seemed like inexhaustible time, patience, and advice for an amazingly large number of people. It is quite remarkable how many people in this ecosystem he has touched, and how many of them are positively moved by the experience. Countless people sought his counsel, and he was always generous with his time. Notably, he was an impeccable listener, a tremendously rare skill that eludes many of the brighter stars in our industry (as well as myself). I always felt like Dave understood and respected me, and I would bet there are many hundreds of others that feel the exact same way.

Most importantly, Dave showed us all exactly what being a great human being looks like. In a post this weekend on Facebook, Jason Calacanis succinctly noted “He was a better friend, a better husband, a better father, a better leader, and a better person than all of us — and we knew that.” When I read these words, I thought “Precisely! That was Dave Goldberg!” I had been thinking the exact same thing over the weekend. Dave was better on all these dimensions and we did all know it. But it was never frustrating because Dave’s greatness was not competitive or threatening, it was gentle, inspirational, and egoless. He was the quintessential standard for the notion of leading by example.

This was Dave’s greatest gift to me —  I now know where true north is. I doubt I will ever achieve his lofty aspirational standard on so many of his unique characteristics. But I know which direction to head. I have a target. And as I circumvent my remaining days on this planet, I have no doubt that I will reflect on his high bar, and think about what I can do to be more like Dave.

I am so grateful to have known him.