The Fallacy of “Smart People”
The Popular Markets Delusion
Moving Beyond Spam: E-Commerce’s Latest Chapter is Rebuilding Relationships & Trust
“They’ve Got No Leverage”
Learnings and Realizations from 2014

The Fallacy of “Smart People”

Yesterday’s primary Twitterati discussion centered around Henry Blodget’s thought provoking piece DEAR SILICON VALLEY, Here’s Your Wakeup Call. In it, he bemoans the lack of responsible, diligent analysis amongst some of today’s leading VCs, and their unbridled, unchecked optimism.

Some were quick to malign Blodget for his representation of all Silicon Valley through the lens of a single (or a couple of investors). But I actually tend to agree with Blodget’s unspoken, yet underlying point: that as the tech world has had a strong ten year run on the backs of a white hot NASDAQ, the new generation of tech VCs have achieved something of a cult, unbounded status (at least amongst my peers).

What do I mean by this? On a couple of recent occasions, take Jet.com’s recent $140M raise pre-product as an example, I’ve responded to the question of “what do you think of that?” with one of my go-to responses: “It feels off to me, but there are a lot of smart people around the table, so I must be missing something.”

But this is a fallacy. Smart people do dumb things. Especially when driven by ego, fear, exhaustion or pressure. All realities of the current venture climate. I don’t think outsiders recognize how competitive the current state of the venture world is. No one, absolutely no one, not even demi-gods like Marc Andreessen are exempt from the strain.

As an aside, if you looked up my bio on paper, I’d probably make the (reasonably) “smart person” category. I went to NYU undergrad, and fortuitously managed to pull down an MBA from The University of Chicago. But even within the context of good choices, I’ve made extremely poor micro-decisions. Two examples:

1. Good Choice: Getting nearly six figures into the middle of the pot way back in 2007 holding two pair versus a naked flash draw.

Bad Micro-Decision: Not asking to run it twice to hedge variance.

Result: Bye bye college tuition. (Bad side of variance)

2. Good Choice: Asking a girl at the bar, now wife, on a date.

Bad Micro-Decision: Playing with fire for years, not fully committing, leaving optionality open.

Result: She waited – now happily married. (Good side of variance)

I suspect that the overwhelming majority of the tech investors, entrepreneurs, and evangelists that I, my peers, the press, etc, look up to are actually quite brilliant.

But it doesn’t prevent them from making poor micro-decisions, even within the context (or guise) of good choices.

I will continue to spend time working to understand the rationale behind any given investment or choice when “smart people” are involved. Yet, confusingly, within flawed reasoning there may exist many pieces of correct and insightful logic. That’s always the mystery.

So thanks to Henry Blodget for reminding me to more diligent, even when otherwise smart people are involved.

The Popular Markets Delusion

As the public equity markets have exploded in the past 18 months to accommodate the growth in technology software companies, it’s become a subject of considerable discussion here at Chicago Ventures. Everything from the recent nosedive in valuations across the adtech sector, Zulily’s precipitous drop, the crowdfunding IPOs, all the way to the continual nuances of everything SaaS.

Though we’d be foolish to ignore public market sentiment entirely, I think it’s equally foolish to base seed stage investments and theses off contemporary trends and momentum. Speaking 15 months ago to StrictlyVC Managing Editor Connie Loizos, Brian O’Malley (then partner at Battery Ventures) now at Accel Partners opined:

What’s interesting, and what has surprised me, is how much people are influenced in terms of which companies they think will break out based on which companies are having success today. 

There’s a lot of emphasis right now on these more enterprise-focused businesses, which has a lot to do with enterprise-focused businesses doing incredibly well on the public market. But the reality of my doing a Series B investment is that I’m not going to be selling for three to five years, and the market might be very different by then. Even still, people are willing to back much less mature companies in the space du jour rather than invest in something that has some scale in a space that’s out of favor.

If what Brian noted is true at the Series B level, how much more so is it true for a seed stage investor like Chicago Ventures.

This is one of the reasons I get frustrated when entrepreneurs try to sell me on the value of their market by referencing recent large acquisitions of similar companies. While those deals may well reflect the general size of the market, it’s unlikely to have a significant correlation to how their market looks in 7-10 years.

As an example, let’s take crowdfunding. Last month’s Lending Club and OnDeck IPOs have reignited chatter in the space. But what many early stage investors fail to recognize is that early thought leadership in the space emerged in 2008-2010, (and, in my opinion) culminated with Charles Muldow’s benchmark whitepaper A Trillion Dollar Market By The People, For the People. Even verticalized platforms such as FundRise have already begun claiming dominance.

This isn’t to say I would never invest in a crowdfunding platform. On the contrary, I am maintaining an acute eye towards an unconventional approach to the space that has failed to connect over the past seven years. The single best lesson I’ve learned from working with Gil Penchina over the past few months is: what has fundamentally changed in the world recently that enables this idea to succeed now when it has always previously failed? This is a nuanced variant of Chris Dixon’s famous “what’s your secret and how did you earn it?” Effectively: Why now? Why you?

This is one of the reasons I remain so fundamentally bullish on digital commerce. With a mere 6% of US retail sales happening online, does anyone reading this actually believe that figure will be less than 12% in a decade? Especially as millenials become the dominant household purchasers?

If I tracked the public markets, I would be shying away from e-commerce: Wayfair is trading at approximately 50% of its IPO price. Zulily is down 60% just in the past 6 months. The sector looks like it’s falling apart.

I remain bullish on digital commerce because I remain bullish on literally every macro factor that could exist. The market will double in the next decade. Friction is fast disappearing across digital checkouts – from single click to bitcoin to Apple Pay. While some traditional retailers may have figured out paid digital marketing, they deeply trail the market on content, community, curation, and concierge services. In 5-10 years, when millenials represent the plurality of GDP, which platforms win? What does the world look like then? If legacy incumbents can’t innovate and millenials spend more online than ever, it sure seems like a lot of whitespace.

Similarly, I remain beyond bullish on bitcoin. While momentum investors have laughably shied away because of the digital asset’s price drop, all the macro factors stack up: Interest amongst world class engineers has never been stronger. A powerful ecosystem is building around influencers. And global figures and corporations from Larry Summers to Docusign to entire countries are experimenting with the technology.

But like everything in life, predicting the future is a balance. Not all actors in the funding ecosystem are rational. With a $40M fund, we can only support world changing entrepreneurs so far. And because pre-IPO investors are affected by public markets, and late stage investor are affected by pre-IPO investors, and expansion stage investors are affected by late stage investors, etc etc, it all funnels down – all the way down to seed stage investors like Chicago Ventures. And sometimes we regrettably, frustratingly need to work within the delusion.

Consider it a work in progress for now; a balance of sorts between predicative imagination and investing into strong secular trends and tailwinds. That’s part of what makes this job so challenging – and so much fun.

Moving Beyond Spam: E-Commerce’s Latest Chapter is Rebuilding Relationships & Trust

The following article was originally published on VentureBeat on January 8, 2015

In a December 11 Bloomberg interview with Emily Chang, legendary venture capitalist Bill Gurley reiterated his belief that “e-commerce is a dangerous game.” He first made the case in a 2012 article, “The Dangerous Seduction of the LTV Formula,” where he argued that customers don’t exist in a vacuum and that many companies poorly estimate the actual economics of the formula.

The public markets might agree; 2014’s most lauded e-commerce IPO, Wayfair, is down nearly 50 percent from its open price, and flash-sales leader Zulily was down 40 percent in 2014 and over 65 percent from its March 2014 high. At the same time, brick and mortar retailers such as Williams-Sonoma and Nordstrom, with their strong online performance, have surged to all-time highs. And in the middle, the next generation of e-commerce startups from Rent the Runway to Instacart to Stitchfix have raised financing at high valuations, while Trunk Club was acquired for $350 million at barely four years old.

So what’s the truth? And what’s going on? It’s my belief that customer acquisition for commerce companies has never been more competitive and is causing considerable drag on traditional players. At the same time, connection focused e-commerce platforms are leveraging network effects for reduced acquisition cost and sustained engagement. Their success is rooted in an authentic voice and restoration of consumer trust — a trust that was broken by an exceeding amount of email and retargeted marketing spam. But e-commerce is cyclical, and early indications suggest that storytelling and content could be the major drivers in the next generation of e-commerce.

To understand the current state of online commerce, it’s important to take a quick look at its history.

evolution of e-commerce

Commodity: Early players such as Amazon and Overstock built their businesses carrying a catalog of SKUs wider than traditional brick and mortar retailers while undercutting aggressively on price, leveraging their lower overhead costs. They had early access to now dominant affiliate platforms, allowing them to quickly acquire customers at scale.

Curation: But that same catalog of infinite SKUs caused real pain for all but the most specific of product searches. This pain led to the birth of discovery- and push-curation focused platforms — from Gilt to Zulily to Wanelo — whose focus was to highlight and promote intriguing products, often specially selected by an editorial team.

This curation focused model succeeded in generating dozens of businesses with hundreds of millions in revenue, but it also suffered from the same macro-factors as e-commerce 1.0. Why?

  • Traditional retailers such as Nordstrom and Williams-Sonoma drastically improved their digitalmarketing teams and presence, making the costs of customer acquisition more expensive. [The systemic problem of paid acquisition is illustriously outlined by Josh Hannah of Matrix Partners.]
  • Although curation models benefited from limited-time sales and the power of refreshed experiences, the majority of revenue still came from email remarketing — a continual competition with every traditional retailer under the sun for inbox attention.

Connection: Which brings us to the present — the era I’ve labeled “connection.” On a macro level, the move towards connection makes a lot of sense. Consumers are overwhelmed by email, social, and retargeted marketing, while at the same time flocking to platforms such as Uber and HotelTonight, whose focus is on constraining choice and cognitive noise. It is the overwhelming noise that I believe created a loss of trust amongst consumers — a trust that can only be rebuilt either via a personal concierge, a welcoming community, or in-person interaction in the next generation of retail stores (Warby Parker, Bonobos, BaubleBar, etc).

The Cycle

In the web curation stage of e-commerce, email continues to drive the majority of revenues by leveraging existing customers. But as email became noisier, mobile focused curation apps such as Poshmark, Tophatter, and Spring emerged to leverage push notifications, attempting to bypass the existing clutter. Push is now undeniably cluttered as well. The same cycle will repeat itself with home-screen notifications.

And this, in my opinion, explains the proliferation of human connected businesses — platforms that are able to cut through digital noise and connect in a real, interpersonal way. As our lives incrementally become more automated and digital, we increasingly crave real relationships in life areas that matter deeply to us — our hobbies, our families, what we eat, how we look, etc.

But this cycle will ultimately have its limits too. Consumers will only have bandwidth for a certain number of personal concierges (many of whom are financially incentivized to sell). Individuals will only have time to engage with so many interest-specific digital communities. As these models inevitably become more competitive and margin-compressed, the increased pressure to sell will break that same consumer trust that was so recently restored. Though human relationships are more secure and long lasting than brand affinities, I predict that in the next downturn, these commercial relationships will be upended in favor of those focused on family, physical health, emotional health, or even nutrition.

The Future: Content, Media, and Stories

In September 2013, eBay acquired an under-the-radar e-commerce startup, Bureau of Trade, whose sole thesis was to build powerful stories, content, and context around items that were otherwise available on Amazon or eBay and see what happened. Would consumers become highly engaged with those stories and shop on the site? Would they alternately search around for the same items at cheaper prices? What effect would rich content have?

A lot happened. CEO Michael Phillips Moskowitz, commenting at the time of acquisition, noted: “The average good on eBay will sell at X purchase price. That same piece of merchandise when covered by the Bureau — when written about by us — created in many instances a 50 to 100 percent price increase. That’s profoundly valuable.” These results speak clearly to the power of storytelling above and beyond the personal relationships of a concierge, physical store, or community.

Moskowitz and the Bureau of Trade aren’t alone. In 2011, Natalie Massenet, founder of Net-a-Porter and former fashion editor for W magazine noted that “Media companies are going to become retailers and retailers are going to become media companies.” Matt Rutledge, who sold Woot.com to Amazon in 2010 and recently launched Meh.com, told Business Insider, “The underlying premise [of Meh] is that we’re building a store that you don’t need to buy anything from to have fun” — effectively, content-enabled commerce.

This January, in a chat I had with Moskowitz, now Chief Curator and Editorial Director at eBay, he stressed the challenge facing e-commerce companies: “One thing I can say about the American consumer is that they’re constantly under an artillery barrage. What do you do when everyone is demanding of your attention? You default to the one thing which provides solace, be it drink, TV, movie, or friends. You lose the thrill of finding out about the new thing because every thing is a new thing.”

The answer? One theory: If platforms can manage to keep you entertained, informed, educated, or otherwise engaged, you’re more likely to transact. The intriguing aspect of the content/story focused model is that it provides many of the practical benefits of the connected models — instruction and assistance, for example — while reverting closer to the pull functionality of e-commerce 1.0, in that consumers are more likely to be exploring on their own, unguided. [Chris Dixon has a great recent post on pull versus push.]

Effectively, these stories and content provide the credibility and legitimacy of connected experts and the entertainment of an active community, but without the overwhelming push pressure and noise.

Having held a variety of marketing roles since 2003, my experience suggests there’s no right or wrong model — rather, e-commerce is a dynamic ecosystem that adapts to the psychological and sociological realities of consumers as preferences evolve; it is a fluid reality. As the era of connected commerce continues to blossom and we move into content commerce, entrepreneurs and investors should be paying close attention to which approaches are becoming cognitively overwhelming and track the historical cycle of commerce.

Ezra Galston is a venture capitalist with Chicago Ventures and the former Director of Marketing for CardRunners Gaming. Follow him on Twitter @EzraMoGee and his blog BreakingVC.

“They’ve Got No Leverage”

There are a lot of things that in the VC world that bug me. One of them is hearing other VCs talk about companies and as part of an argument or plan mention that they don’t have any leverage.

On the one hand, I totally understand where those in the investment community are coming from. Our job, as venture investors, on a fundamental level, is to return money to the stakeholders in our fund. Given that, it might seem that the best way to maximize returns is to negotiate for the best possible terms at the long-term expense of the founding team. A company with “no leverage” would therefore be more likely to face an aggressive negotiation.

But if I’ve learned anything from methodically studying winning consumer internet models, it’s that the best companies create a win/win outcome both for their customers and their employees. Let’s take Trunk Club, for example. Part of the company’s success is rooted in the fact that their stylists are extremely well compensated. Customers look and feel great while employees also win from the company’s success. One of the pioneers in this model was SouthWest Airlines: literally every employee from the pilots to the janitor participate in a company-wide profit sharing plan. It’s often cited as one of the reasons your service is so good – every employee is literally connected both with the overall status of the business and their own compensation.

The same applies to relationships with customers and building a growth base. Dan Goldman, former Director of Marketing at PokerStars, the undeniable category leader in online poker, relates that whenever he brought a marketing initiative to Isai Scheinberg, the CEO:

“Almost any time I brought some huge proposal to Isai, he asked the same question: “What if we just gave that money to our players?”

As a customer, we all felt that. While PokerStars was growing, despite the billions of dollars they spent on customer acquisition, it mostly felt that the customer was the focus and getting a great deal.

So if it’s true for employees, and it’s true for customers, why should it be any different in venture investments?

The inherent problem with the statement “they’ve got no leverage” is that it creates misalignment between investor and entrepreneur. It may well be factual. But if an investment is predicated on making founders (or employees) unhappy, I’d guess it’s likely to end badly (caveat: having only been in this business for three years, I don’t have a large enough sample size yet to know. But it feels wrong,)

Like everything in life, it’s ultimately a balance. Not every company can raise money at staggering terms with the founders feeling like rock stars (and investors feeling like rock stars for getting access!). In many investments we’ve made where I’d describe the process as “smooth” or “positive” there have still been tense moments and some unhappiness. Often, founders are unhappy about valuation, for example, yet that price is literally the only way to get a syndicate together. Alignment can sometimes be as simple as a transparent communication, where both parties air their priorities and concerns. I’ve found that when I relate to an entrepreneur that we’re not asking for a vesting schedule because we want to handicap them, but rather because it (a) protects them if a co-founder leaves the business and (b) we have a fiduciary responsibility to our investors to adhere to market norms, they get it really quick. Instead of being untrusting jerks, the conversation is re-aligned of one where both parties care about long-term success.

As with most of thoughts, tl;dr. But the point is to focus on win-win scenarios, not on besting another party. Frankly, it’s Negotiation 101.

Learnings and Realizations from 2014

It’s been a while since I’ve written about daily VC life issues on the blog. One of my new years resolutions is to get more active on here. To inspire myself to do so, I’ve installed a new theme that’s mobile friendly and easier to play around with!

I’ve met lots of students over the past 12 months, interested in VC, who’ve noted they’ve gotten a lot out of the blog. It’s rewarding and encouraging to keep writing. I will continue to publish industry whitepapers and analysis on TechCrunch, Venturebeat and re/code, but will post Junior VC related info and informal daily thoughts here.

As I look back on 2014, I figured I’d outline some of my biggest learnings and realizations from the past year.

1.  Turns out that I didn’t know what I didn’t know – As 2013 came to close and marked 2 years in the venture industry, I felt confident that I finally “knew what I didn’t know.” I was wrong. The scariest thing about this year was finding myself in more and more situations where I simply didn’t know what to do. And although it’s fun to always be exploring in a profession, it’s scary when you don’t have a roadmap.

2.  Behind the Scenes > Public Decisions – Much of the Twitterati and VC blogs focus on investment theses, emerging technologies, industry whitepapers, etc. And that’s clearly an important part of the job. But I have to admit…I don’t think it’s the most important part of the job.

About a year ago I started wondering to myself why VCs are (theoretically!) so well compensated when the checklist for making decisions (founding team, traction, references) are fairly straightforward. Again, I feel obnoxious underplaying the investment process but the truth is that I feel that there are many smart people who could be great investors (I felt this way about poker players too!).

Where I think great VCs differentiate from mediocre VCs is in process, communication, empathy and management. What I realized in the poker world is that fundamental skills were ultimately secondary to bankroll management, game selection, and emotional balance. I made multiples more money than players that were 10x better than me, because they took unhealthy levels of risk or were emotionally volatile. I think the same concept applies in VC: you can have the world’s greatest theses, but piss everyone off, run deals from start to finish terribly and never become great.

Tl;dr: I believe that the behind the scenes intangibles create more value than the public theses.

3.    Have Convinction – This was certainly the year where being contrary became cool, culminating in StartupLJackson’s “The Counterintuitive Thing About Counterintuitive Things.” It got so over the top that I started to wonder if the counterintuitive market had matured to the point where being cliché and simple was the new counterintuitive thing?

In all seriousness, this is a tough business to be confident and different. It is so easy to follow others – whether that be other venture firms, other advisors, etc. Following is the easy bet; no out-of-town associate ever got fired for following Andreeson-Horowitz.

The good news is that I learned what I need to feel in order to have conviction. There was one moment this year – one entrepreneur, one company – where I simply knew I was right. Sometimes you meet an entrepreneur and can just sense that they will literally brute force their own success. I was 100% sure this person would do good things. My partnership didn’t like the model and I dropped it after 15 minutes of pushback. It’s hard to gauge success but all indications point to this one being a homerun.

Whether or not that deal ultimately turns out a winner, I learned my own sense of conviction: that feeling of energy, enthusiasm and confidence that will enable me to pound the table and fight for an investment in the future.

4.    Take Personal Risk – I am really passionate about diving deep into businesses and connecting with the leaders who aren’t CEOs or COOs. The most important people in an organization can often be lead engineers, VP Sales, VP of Care, etc who simply fly under the radar.

I realized that I wanted to connect with more of these people because I thought about their jobs all the time. While it started selfishly, I figured that other people also wanted to geek out about similar topics, meet like-minded people, and hang out. I thought being at a venture firm (and thereby relatively unbiased) provided a unique platform for putting people together a room and taking responsibility for the evening.

And so I started an event series called the Building series. Most people I spoke to about it were dubious. I’ve even been paying the $700/event overhead costs out of pocket because sponsors were skeptical. I could’ve really tarnished my own reputation if people had hated the events. But I’m fortunate that they’ve been a real success. In addition to some phenomenal speakers from Uber, GrubHub, Handy, Trunkclub, and SpotHero, we’ve had attendees ranging from local executives of billion dollar SF companies, to execs from local growth stage companies, to unfunded super early stage companies.

Most importantly, I’m starting to make friends through the effort. I love making new friends. New people to bounce ideas off…ask for feedback on an entrepreneur I just met. I can’t wait for the next event and they keep me going when things are slow.

5.    Stay Proactive – One of the struggles of the Chicago Ventures team is that the GPs are well connected and big personalities. Everyone knows them and they have wide networks.

This poses a problem for me working up the ladder. I saw that I ended up spending so much time being reactive to their dealflow and relationships that it hindered my ability to develop my own value. At the same time, the quality of inbound companies and relationships was so high that it was hard to argue I should be prioritizing my time on lesser opportunities simply because they were my own. In my opinion, this is one of the great catch-22s of the venture business: you need to build your own value chain and brand – but being a true team player is often the most value additive thing for the firm. That said, if I’m not creating my own unique value then I’m a commoditized grunt and they could hire anyone.

Like everything in life, it’s a balance. But I realized that in order to feel fulfilled I had to create my own fate: start producing my own content, start my own event series, build my own relationships, find companies and spaces that I alone was passionate in.

The only way to be great in this business is to be proactive. At the same time, there’s a danger of trying to push the pedal too hard and do too much. Again, it’s a balance. But if you’re reactive, then you’re a commodity.

 6.    I Need to be Independent Yet Need Mentors  - I think that a venture firm is one of the perfect places for me because I’ve never really done well working for other people. I’ve had two formal bosses (before CV) over the course of my life: Tina Wells at Buzz Marketing Group and Taylor Caby at CardRunners Gaming. In both of those roles, I was given nearly limitless freedom, budgets, and independence. At CardRunners, Taylor used to even jokingly call me “CEO.” 

Both Tina and Taylor were phenomenal managers because they both recognized that my personality was one that craved autonomy, decision making, and growth – while also demanding regular mentorship and positive feedback. I had a weird balance of both wanting to be my own boss, yet still requiring some positive reinforcement to keep on attacking.

I like to think I was highly successful in both roles because I understood the industries, understood the problems and just went out and creatively executed until someone told me to stop (or stop spending).

The venture world operates similarly in that it’s highly unstructured with little direction. Although I’d typically excel in this environment, I struggled at first because I didn’t really know where to start. I’d go to events and meet people but didn’t know what to do with that information or with those relationships. I would put my thoughts to paper but wasn’t quite sure who would read them or if anyone would care. I would write investment memos but wasn’t sure what analysis was helpful. I’ve figured most of that out.

All that said, I still have two weaknesses heading into 2015: (a) This is an apprenticeship business and I haven’t had the opportunity to closely apprentice an expert. I have mentors, and I’ve figured a lot of it by trial and error – but it’s the difference between having Tiger Woods’ swing and Jim Furyk’s. Both win majors, but Tiger’s is fundamentally beautiful. I don’t want to just be a winner – I want to be great. (b) The downside to having my personality is that I feel resentful and anxious when I’m not in charge of my own fate. VC is a business where so many things are out of your control –from company successes to downstream financing to fund management. It’s an industry which negates my inclination to have control at all times. Even in poker, while any given hand had an element of chance, I knew what sample size I needed to hit to outrun short term volatility. Sample sizes in all aspects of venture are so small – from financings to theses to career decisions. It is scary and I’ve got to get a better grip on it.

I’ve put a lot out there and hopefully someone’s gotten through it. I’ve decided to be more open and honest this year. Please treat that openness with respect.


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