Soft Valley

How are Silicon Valley and the VC business different today than they were 15 years ago?

Venture has gotten much more competitive. In seed and late stage, there’s hyper competition. What I think that has caused, unfortunately, is that most VCs live in fear of a bad reference.

From entrepreneurs. I think Silicon Valley boards are probably the softest they’ve ever been. If you go back to the old days of venture capital, you hear stories about the Don Valentines of the world just iron fisting their way through a board meeting. [Valentine founded Sequoia Capital in 1972 and was one of the early investors in Apple, Atari, Oracle, Cisco, Electronic Arts, Google, and YouTube.] No one does that today, and it makes the job of a VC a lot tougher. In a board meeting you can’t influence through fiat or contracts. You have to do it all through persuasion.

Hyped Valley

When I start seeing things that are overly promotional and fall into the realm of entrepreneur-as-snake-oil-salesman, I always get concerned because I know that’s unsustainable. It’s also bad for Silicon Valley’s image. Silicon Valley looks the worst when we start acting entitled. You know, “We get to eat the world. We get to disrupt everything. But guess what? We don’t actually want to be profitable. We don’t want to be held to your rules. We don’t want to be accountable. We don’t want to have to go public.” That’s pretty entitled thinking. We look like babies.

I can remember being at a conference where the Fab CEO was on stage. Someone asks, “What’s your sustainable competitive advantage?” And he says, “Oh, my co-founder is the best designer on the planet.” I thought to myself, “You know, based on everything I’ve read about business, starting back to my Texas days and studying, that doesn’t add up.” It was like this doesn’t make sense. It eventually became true and didn’t make sense. [Fab raised $330 million to create an Adobe Flash-based e-commerce site for small design shops to sell their wares. It was valued at nearly $1 billion by summer 2013. Fifteen months later it was effectively dead.]

Some of the work the Wall Street Journal has done on Zenefits is also worth looking at. I think the CEO was quoted as saying, “We’re going to be $100 billion in revenue.” What is going through your mind to say that? I think they ended up doing $35 or $40 million in revenues last year. So even $1 billion, 1/100th of that is plenty aspirational. [Zenefits just replaced its CEO.] When I see that stuff, I feel like we’ve trained entrepreneurs to value the wrong things, to just be promoters.

Today, as the backer of marquee-name companies like Uber, Twitter, OpenTable, Yelp, Zillow, Dropbox, Instagram, and Snapchat, Gurley and his firm Benchmark Capital have helped make Silicon Valley arguably the hottest place to start a business career.

Downturn

Anyone that studies finance for like a year should walk away with the attitude: micro, maybe; macro, no chance. It’s just so complex, there are so many variables.

I believe that in a world where capital is super easy to raise, it’s a net negative for great entrepreneurs. So if we’re in the business of backing the best entrepreneurs and helping them build long-standing, sustainable companies, this is a horrible environment for that.

A good entrepreneur is systematically advantaged in an environment where it’s tough to raise capital. I would go as far as to say that you could have 60 years of business experience. You could be Jack Welch. You could be Warren Buffett. You could be [Jeff] Bezos. And it doesn’t prepare you for a world where your less talented competitor can afford to lose $300 million next year and maybe the same the year after because of all the money they’ve raised. There’s no rule book for that world.

Over Valued

• Most founders are biased towards optimism (as they should) and have a hard time optimizing for the realities of tough times.
• An entire generation of entrepreneurs & tech investors built their entire perspectives on valuation during the second half of a 13-year amazing bull market run. The "unlearning" process could be painful, surprising, & unsettling to many.
• Previous "all-time" highs are completely irrelevant. It's not "cheap" because it is down 70%. Forget those prices happened
• Valuation multiples are always a hack proxy. Dangerous to use. If you insist, 10X should be considered AMAZING and an upper limit. Over that silly.

Layoff

• I hate the 5 to 10 percent layoffs. You don’t get any material impact to lowering your expenses. Yet you get all the cultural negatives of having done a layoff. You get 100 percent of the pain and very little gain.

Benchmark never changes our investment cycle due to economic swings
Our firm has a very unique focus. Around 85 to 90 percent of our funds are deployed on first-money and early-stage investments. And our approach has become even more unique because so many of our competitors have gone multistage.

And once you start doing late-stage things, the current environment has a drastic impact. But if you're doing early-stage, these kinds of swings don't really put you off the next incremental investment. There have been plenty of great companies started in the troughs to suggest that there's no reason to stop investing.

The same thing is true at the peaks. There were firms that pulled out in '96 because they thought things had expanded too broadly, and they missed three of the greatest years of returns in the history of the business.

We really try to learn from our mistakes. We tried to expand internationally once, but it didn't work for us. So in about 2006, 2007, we capitulated and went back. And our conviction in our focus was even stronger, because we saw that we did better work once we refocused.

We had that on our mind as everyone in the Valley started expanding in more recent times. And I will tell you, for the six or seven years prior to the past year, people would meet with us and tell us that we were stupid, that we were leaving money on the table. But in the past six months, that's all reverted. Now it's all, oh, you guys are still brilliant.
There is another reason why I like our model. We're running much smaller funds than some of our peers, who probably pull down ten times the capital we do each year. Those firms have massive management fees as a result. As an investor, I just take more pride in us doing well when our limited partners are doing well. So if the majority of our compensation is on the carry side instead of the fee side, I just feel better about it.

Why Benchmark Special?

Some of its most successful rivals say Benchmark is the firm they admire— and fear—the most:

“They benefit from being extremely focused” - Jim Goetz, Sequoia

Roelof Botha, who leads Sequoia’s domestic operations, said Benchmark’s structure gives the partners “incredible clarity” to spot lucrative technologies.

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.

Benchmark’s goal is to avoid the generational struggles that have hobbled other Valley firms:

Young people end up the hustlers and the old people sit in place. That’s the biggest secret of Benchmark. When our founders were at the peak of their powers, they handed us the keys.

Focus

I think all VCs work hard to create a narrative for founders/entrepreneurs that is beneficial to that VC's position on the field.

We invest as an alternative to seed (or pre-seed or pre-pre-seed :)) all the time. Love getting in on the ground floor. And we have confidence in our views on categories and GTM approaches, so unafraid to start that early.

Staying Small

My belief is that starting with 2008 — I mean, what happened in 1999 and 2001 starts to play a role — but it was really 2008 where all the LPs kind of woke up and said, “You know, enough is enough.” For firms that invest in Series A and B, it’s become, I think, hard, and I think it’s become harder to raise funds in that sector. For various reasons, the seed stage — just because more wealth has been created in the past three or four years, so there is ample cash there. And then, for reasons that are still quite curious to me, the late-stage market has just been full of money …but we’ve got a small set of LPs that we’ve been with forever, and it’s not a process, really.

We got distracted from our focus in early 2000, and it took away from what we loved to do. So our resolve is partially a function of the fact that we lived through that, so we think long and hard before we do something that would expand the scope of what we’re doing, just mainly because it distracts you.

We experimented with expansion coming out of ’99. We launched Benchmark Europe and Benchmark Israel and tried to replicate what we do, recognizing that entrepreneurism wasn’t a U.S.-centric thing. And it caused all kinds of distraction. We had done a billion dollar fund in ’99. So we told our limited partners in 2007, “We’re going to $400-million funds. We’re only going to do early stage. We’re not going to do international. We’re not going to do growth. We’re not going to do seed.” I think it was very fortuitous timing because almost three or four years after we did that, all of our competition started scaling out in huge ways into different geographic sectors. They became stage agnostic. They raised huge, billion dollar funds. And, to me, that’s been the seminal event that led to our success — that we chose to focus. And being focused as an investor I think is the most important thing. It means giving up the notion that you’re going to scale up and take over the world. But I don’t believe that there are network effects to venture.

Business Principles

Distribution Strategy

Liquidity Quality by Bill Gurley

*Strong liquidity quality — word of mouth growth from passionate users who consistently came back to the product fed a flywheel that "simultaneously better served the individual desires of the customer and also contributed to higher inventory turns, fewer write-downs, higher capital efficiency and higher ROIC

I've come up with this phrase I use internally that I made up — so I one day, I'll have to write a definition of it — called Liquidity Quality. And I tell entrepreneurs, I care way more about Liquidity Quality than I do how broad you are. We can use venture dollars and growth playbooks to go broad if the fire's burning bright. So how do you get this liquidity quality high? Jeremy (Stoppelman from Yelp) doing things that don't scale at those nightclubs in San Francisco, and people being super passionate in their reviews, frequency being high, the quality of the experience, even though is in a very small area? And so I very frequently run into entrepreneurs who think they need to expand to 10 cities really quickly to raise their A or B or whatever. And I'm like, no. If you have like incredible unit economics and growth metrics in a single city, where it's obvious that your playbook is working and things are spinning and things are getting better, you basically have network effects. That's way more interesting.

If you have incredible unit economics and growth metrics in a single city, that’s way more interesting than rapid expansion. When yelp launched, there were 2 other competitors. Both of them took the ABI small business listing and uploaded the content. They had way more breath than Yelp, but they had no depth.

Past, Future

Businesses are complex adaptive systems that cannot be modeled with certainty.

The past can be a poor guide for the future if the future offering is materially different than the past. Let’s first dive into the TAM assumption. In choosing to use the historical size of the taxi and limousine market, Damodaran is making an implicit assumption that the future will look quite like the past. In other words, the arrival of a product or service like Uber will have zero impact on the overall market size of the car-for-hire transportation market. There are multiple reasons why this is a flawed assumption. When you materially improve an offering, and create new features, functions, experiences, price points, and even enable new use cases, you can materially expand the market in the process.

If you had to do it all over again, would you do it any different?

That’s a great question. I get asked that in every interview I do. I probably would have come straight to Benchmark, and I certainly would have tried to invest in Google. The second one would be the №1.

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