Debunking The Skill Gap Myth in Daily Fantasy
A New Reality
Multiple Compression In The “Winter” & Why It Matters
More Than Just a Podcast
Is It The End Of The World As We Know It?

Debunking The Skill Gap Myth in Daily Fantasy

Daily Fantasy Sports are under a full on assault: allegations of “insider trading,” a hyper aggressive (if not overwhelming/annoying) advertising strategy, and multi-directional claims that DFS can’t be beat because it involves too much skill.

There are lots of legitimate concerns which I will address in future posts over the coming weeks. But the most damning – that DFS suffers from “too much skill” – is inherently flawed.

Here’s why:

Too Much Skill

A McKinsey study from September is making headlines (aka the Twitterati is going insane) after it noted that 1.3% of DFS players – the sharks – account for 91% of the winnings.


One of my favorite daily reads, Ben Thompson of the newsletter Stratechery, used that data to note the following:

In fact, as the McKinsey article concludes, the fact that Daily Fantasy does require skill is one of the biggest threats to DraftKings and FanDuel: the flipside of a few players earning most of the money is that there must be a counterweight — some number of big fish willing to lose and lose substantially.

Here’s the thing: while these numbers make for a great click-bait headline, in actuality it’s a non-issue. Why? Because betting markets fundamentally demand winners and losers.

One could make the claim that in a fairer world, the winners would win less and the losers would lose less. But let’s unpack that: for starters, the headlines are deeply skewing the numbers. While it’s true that the “Big fish” are losing 44x more than the “Minnows,” they are also playing stakes 66x higher. Keeping in mind that Fanduel spreads daily games with $1,035 buyins, the idea that affluent bettors regularly playing $300-$1k buyin lose $1,000 over the course of “half an MLB season” is not that surprising. If anything, based on my experience, it appears light.

Let’s also not forget that for the “minnows” who lose a full 50% of the money they deposit – $25 of $49 deposited – that wagering on DFS is entertainment. It’s a little known fact that traffic to online poker sites during the late 2000s was directly inversely correlated to new airings of American Idol: when the show came on across time zones, traffic would accordingly drop in those geographies. Low stakes betting is entertainment. And given the low buyin amounts (down to $5) I’d be shocked if, on an hourly basis, it were more economical for these players to go to the movies than lose at DFS.

I had a former member of the Full Tilt Poker Board of Directors in my office a couple of weeks ago. I asked him to verify the often-cited statistic that approximately 95% of online poker players were losers. He confirmed this. Going back to those McKinsey results…a full 15% of DFS players appear to winning – currently 3x the rate of online poker players.

But let’s take a step back and all agree on something else: DFS is in its absolute infancy. The level of scrutiny being placed on DFS, especially given its youth, is unparalleled by any other betting market (skill or pure gambling) in the history of the world. That means that a lot of the less salacious factual realities – though entirely normal in the adolescent development of any market – are being distorted as structural flaws. When in reality they are fundamental pre-requisites to building a healthy ecosystem.

As always, I draw a lot of inspiration from my years in the poker industry. And here’s what I observed: when markets are imbalanced, with strong financial incentives on either side, unless those markets demand some genetic prerequisite to entry, the financial opportunity will move those markets closer to equilibrium.

And here’s what I mean – in plan English. As an example, there are millions of brilliant, hungry, deeply incentivized college student with lots of disposable time and some disposable income. Many will experiment with DFS. Most will lose; some, however, will recognize that only 1.3% of players are using advanced statistical modeling and will hunker down for weeks building their own models until they start winning. The effect of this is that win-rates for the top 1.3% of players will begin to decrease. And instead of 1.3% of players winning 91% of all the payouts, the market will move towards 5-10% (my guess) winning 91% of the payouts.

The Historical Ecosystem Cycle:

In a recent Bloomberg Masters in Business podcast featuring Nate Silver, the most frequently used word when responding to questioning was: “historically.” History is paramount. And in the case of DFS, we have precedent of ecosystem evolution by looking at the history of financial markets, poker, and gaming. As noted my analysis is primarily influenced by the evolution of online poker.


Two major trends will begin to develop: (a) A formalized, professional ecosystem of third party DFS training apps will begin to emerge, (b) The sites themselves will invest in educating players and normalizing skill levels. Case in point is that we’ve already begun to see this with Fanduel’s acquisition of Numberfire.

Here’s a breakdown of what really happens in these stages –

Stage One – Early Adopters:

  • DFS is currently holding somewhere between Stage One and Stage Two.
  • Early adopters – those who understand the game theory of lineup assembly and experimented early have a significant skill edge in DFS. The winners have benefitted greatly from the influx of players to the ecosystem.
  • An increased focus on DFS – between its media coverage, heavy advertising, and mainstream profiles of large winners (especially if they can build a spectator/televised component) – will cultivate an aspirational user base and begin to inspire players of all skill levels to improve their lineup performance.

Stage Two – Third Party Apps:

  • Consumer grade player analytical software and lineup generators will begin to make their way to market (I would know I’ve been pitched on several).
  • Subscription training sites, founded by pro DFS players will begin to emerge offering unique insights into lineup formation (I would know I helped to build Cardrunners – a similar business in the poker world). RotoAcademy is one example but there will be more.
  • Peer to peer coaching marketplaces connecting DFS pros directly with recreational players willing to invest in their lineups will emerge.

Stage Three – Platform Sponsored Education:

  • As platform growth slows because market expansion slows, the site operators will re-prioritize on maximizing customer revenues rather than raw customer acquisition.
  • The platform operators, cognizant of the increased revenues/rake as average skill level improves will launch their own efforts to draw the ecosystem closer to golden mean (where everyone breaks even long-term).
  • The operators will either: (a) Launch their own, recreational player focused, free to learn, educational platforms just like Full Tilt Poker Academy, (b) Will subsidize learning on third party applications such as Truly Free Poker Training and/or (c) Purchase late night programming slots on mainstream television channels such as Fox Sports to air informercial-like educational programming.
  • The effect of all this sponsored education is that the baseline performance of even low volume recreational players increases.

Stage Four – Platform Defection:

  • With the skill gap closing across the board two important shifts begin to take place:
  • Lesser winning players, who had previously fed off utter amateurs, no longer find it time-effective or profitable to drive volume on the platform. They are economically incentivized elsewhere and will leave the platform.
  • The winningest players on the platform who have built bankrolls of winnings in the millions of dollars will no longer be able to drive large ROIs on the platform because the stakes are not high enough. They will divert their attention off platform, either to professional sportsbooks or private markets that open.
  • These two defections serve to actually increase the skill gap on the platform as the winningest players and breakeven or lightly winning players leave the platform. In an ideal world where the market continues to grow and customer acquisition remains stable, this shift actually creates an opening for the next generation of players to move from “minnow” to “shark,” replicating the cycle of the ecosystem.

The Structural Issues:

There are legitimate structural claims against DFS, most importantly that novice players receive no protection from high stakes sharks in that multi-entry allows for lineups to be replicated without friction across buyins.

That said, this blog assumes (and I am taking for granted) that those structural issues (which are real) can be solved, either by limiting the number of entries per day (as Fanduel has done) or by creating a more dynamic pricing system or by eliminating identical lineups. Or, in reality, by some solution I haven’t even considered.

I don’t know how they’ll be solved, but I believe they can be. The purpose of this blog is to disprove the detractors who believe DFS’s skill gap is permanent. It is not. It will evolve.

A New Reality

If you’ve enjoyed reading my blogs over the past months or years you might have noticed its been a quiet few weeks from BreakingVC.

There’s a good reason: five weeks ago I was blessed with the birth of my second son. Combining 2.8 years of combustible energy with .08 years of fragility has taken a toll professionally. Though I’m finally coming out of the woods, I owe an apology to the dozens, if not hundreds of people, who have had to put up with slow response times, if not extended silence from me. It’s not how I like to do business, but I am proud that I was able to fully dedicate myself to my wife and growing family.


I don’t think my family could have survived at any level of sanity without the paternity leave graciously provided to me by my teammates: Stuart, Kevin, Jason, Lindsay and Peter. I have a number of friends currently expecting child #2 (or beyond), several of whom have no paternity policy or whose partners have no maternity policy – or at best, an unpaid leave. I can’t understand that. At all. My friends are scared. Their wives are scared. A month later, my wife is still recovering physically and needs a lot of support. Emotionally, I was once advised that the first three months are considered a fourth trimester – meaning lots of growth, unknowns and volatility. To put employees in a position that causes undue strain on their marriages and other children makes no sense to me. It’s illogical to assume they will perform better at work. On the contrary, rather than a few weeks of absence, an enterprise might earn themselves a full year of underperformance. Here is the White House’s report on the topic.

According to the Center for American Progress, the USA is the 10th worst country in the world for maternity leave. And dads aren’t far behind. I’m not so good with being a “causes” evangelist…probably because I find that most of them I can’t authentically lend my voice to – or if I have to be honest, because I’m a bit scared of being flamed by those with opposing views. But supportive maternity & paternity policies are ones that I feel I have a deep obligation to. If companies do the right thing, employees have every incentive to remain loyal. Because of that, I’m committed to fostering and cultivating a strong parental culture at all the companies I invest in.

Expect the startup/VC focused blog to come back starting next week. For now, I’ll leave you with the ACAP’s infographic via The Huffington Post

Multiple Compression In The “Winter” & Why It Matters

To say that today was a rollercoaster would be an understatement. While I recognize I’m a relative novice to the financial markets, watching fast selloffs and panic selling is always mesmerizing – no matter how many times one has seen it.

I don’t know how Bill Gurley always seems to have impeccable timing, but last Thursday night (before Friday’s market pullback which started this whole mess) he ripped off an 8 piece tweetstorm where he warned that recent corrections in the public markets could have an adverse impact on the tech startup world. Re/code chronicled those thoughts in a piece entitled Winter is Coming, You Ready? Within the tweetstorm, Gurley made the following two points:

At the close of today’s markets, I decided to do a quick analysis to see how true that is. Especially with a few of the stocks I know very well: marketplaces such as Etsy, Grubhub, Shutterstock & Homeaway. As some of you may recall, I penned Unpacking Etsy’s S1 on TechCrunch a few days ahead of its IPO back in April. Here’s how those stocks stacked up back then on a GMV, Revenue & EBITDA basis –

Recall that on the day of its IPO, $ETSY actually spiked to an Enterprise Value of over $3 billion dollars so imagine an EV/GMV of close to 2x and an EV/Revenue of nearly 15x.

I re-ran the numbers at the close of today’s market and updated the company financials to reflect their trailing twelve months (2nd half of 2014 & 1st half of 2015) as opposed to just 2014. Here’s what they look like now:

As is evident, Gurley is 100% correct. Its not these companies aren’t growing (see below) its that their multiples have been cut by 50-65%. Only Homeaway seems to have avoided the carnage, most likely because it is the eldest, most profitable, with the strongest balance sheet. At the same time, to those of us in the tech world, it is the stock most likely to be entirely disrupted – by Airbnb – but no matter. The market is looking for stability, not growth. You can see for yourself: the market is applying nearly identical multiples to both Etsy & Homeaway – two companies at very different stages of growth and maturity.

Here’s why this matters: Most VCs (including Chicago Ventures) have typical rules of thumb we like to apply to companies when considering an investment that have (at least roughly) some correlation to public market comparable. For example for marketplace businesses, we’ve historically looked for a valuation to be anywhere from 1.5-3x annualized GMV. For an e-commerce business it might be similar. Its dependent on growth rates, and we expect to pay higher than public market multiples because our startups are growing 2-10x year/year, not 60%. But as public market multiples come in, we’re forced to reevaluate. For instance, if we’re considering a Shutterstock clone (bad example, but you get the point) and we’re forced to say – “Well, it really only has $800M market potential, not $2.5 billion potential” – then it drastically affects entry price.

How long current multiples will last is anyone’s guess – or whether they’ll have a snap correction. But one thing seems clear to me right now: my generation of younger VCs who were trained to assess top line GMV growth first will soon be forced to master other, more fundamental aspects of a business’ economics.

For those keeping score at home, here’s my assessment of those 4 public co’s trailing twelve month financials. I moved quickly to get this out the door before the market close & there could well be errors:


More Than Just a Podcast

I was honored when Harry Stebbings, founder of the 20 Minute VC asked me to be a guest on his show. He’s had a number of my close friends on the show as well as some industry heavyweights such as Brad Feld, Jason Calacanis, David Pakman and others.

The full audio of our interview can be found by clicking here.

But there’s a deeply important lesson behind Harry’s podcast – that you create your own destiny. Harry is 19. And he has the most popular podcast about venture capital in existence.

Between Kellogg and Chicago Booth, I would imagine I have between two and three dozen MBA students reaching out to me every year about how to break into VC. That number doesn’t include several dozen more from various professional positions in Chicago who are interested in VC, etc etc etc. All of them are looking for help – and that is fair – but they are looking at the world traditionally. Very few, if any, are brute forcing their own path.

With nothing more than a Skype account and a few cold e-mails, Harry has over the past year gained access to some of the top venture capitalists and entrepreneurs in the world.  Frankly, I’m jealous.

The podcast started simply enough when Harry recognized there was a massive amount of interest in VC, but no focused podcast less than a hour+ – effectively criminal in an age of more bite sized information. So he launched a product to solve it.

Harry’s story actually inspired me to reach out to some of the VCs I look up to for interviews on my blog (and those will be forthcoming in the next few weeks). This is a karma driven business and no one that I know of is succeeding who wasn’t mentored or given by assistance for no good reason other than pure altruism.

I have absolutely no idea if Harry is a good investor, or a good venture analyst (sorry, just the truth!). But a lot of investing can be taught – it’s access that is prohibitive. Harry is the latest proof point that there are plenty of openings to build a reputation, create relationships, and make a mark in this industry.

Is It The End Of The World As We Know It?

I don’t know. Maybe?

Over the past few weeks, we’ve begun to see a number of high profile startups failing to raise new rounds of funding such as Homejoy, GoodEggs and StumbleUpon:

While I’m by no means the first investor with this observation, I do believe it reflects an acceleration in the number of publicized growth stage companies failing to raise continuation capital (of course, given the sample size, timing could be entirely coincidental, but it doesn’t feel that way). In fact, it’s a timely development because it’s specifically the lack of companies failing that is concerning a great number of venture focused LPs. For example, an LP friend of mine recently noted the following to me –

The larger issue is that loss ratios in venture right now are way out of whack and not a lot of companies are failing. There are obvious outliers like Fab, Homejoy, Zirtual and Secret, but still a lot of unrealized markups. So it really comes down to how good the companies are that you’ve invested in and how durable they are.

What needs to be unpacked from that quote is that if “not a lot of companies are failing,” then it follows that someone must be supporting them. So it’s imperative to ask: who is supporting them and why? The who, in my mind, is reasonably well understood at this point: everyone from traditional growth firms, to corporate venture, to mutual funds, to wealthy foreign family offices. The why – at a high level – should always be: expected value, with “expected” certainly the operative verb.

But those expectations and estimations of future value may well be changing. A friend at a Top 10 growth firm noted to me the following this morning:

I think you’re right and, yes, seems like folks are pulling back.
One, public markets are the ultimate arbiter of truth and they’ve weighed in quite negatively on the mid-cap tech stocks : Yelp, Shutterstock, Marketo, etc etc
Two, the whole benefit of the mezz-pre IPO / late stage venture round : it’s a bridge to an outcome. Not a bridge to another bridge. If those late capital rounds are just helping you kick the can down the alley, then forget it. If you have a reasonable and purposeful plan in place to i.e. use the $ to tweak economics, or crispen the public story, or grow just a year or two more so you can have size and strength to show — then absolutely.
The consumer companies are struggling in particular. Haven’t quite nailed unit economics in most of these cases. People are just like – what do I get from this round?
There’s a lot of irrationality in the Seed/A/B rounds and a lot of rationality in the C/D/E rounds. Those two dynamics are coming to a head.

As a MicroVC with four years of investment experience under my belt, I won’t pretend to understand the nuances occurring at every stage of the ecosystem, but I will note a few of these “dynamics” I see coalescing:

Scale it Before You Nailed It

As a startup community, we are living in age of scale first. The reasons for that are below in the next section. And while there will be winners, scale first is both tremendously expensive and volatile. From the GoodEggs blog:

The single biggest mistake we made was growing too quickly, to multiple cities, before fully figuring out the challenges of building an entirely new food supply chain. We were motivated by enthusiasm for our mission and eagerness to bring Good Eggs to more people. But the best of intentions were not enough to overcome the complexity. Today we realize that in order to continue innovating in San Francisco, our original market, in order to continue figuring out all the complexity that is required to achieve our mission, we cannot productively maintain operations in other cities.

Similarly, from Ellen Huet’s Forbes article on Homejoy:

Homejoy faced pressures dreadfully familiar to many successful young startups: Raising a huge round (in this case, $38 million in 2013) comes with investor expectations of equally huge growth. To meet those expectations, Homejoy expanded quickly — too quickly, former employees said — into new and international markets, at one point opening in 30 cities in six months.

Cheung “was always telling the growth story … because we need to have this story to raise the next round of capital,” said the same former employee. “She really felt that if the company stopped growing really, really fast we’d be dead.”

As an investor, I am guilty of advising several of my investments to scale too quickly. What I’ve begun to realize is that in some ways it’s actually easier to scale than refine a business model.

For example, early on in my career playing poker professionally, I faced the following dilemma: I realized I was a big winner in $400 buyin games, but only a breakeven player in $1,000 buyin games (where the skill level was higher). I had two choices: I could study, grind, experiment and take a few months learning the ropes in order to beat $1,000 games. Or, I could simply play more tables of $400 games (thereby playing more hands per hour & winning more money). Initially, I chose the latter because it was the easier decision – I simply needed to play more (even if slightly more distracted) to win more money. I ultimately realized this was a mistake and spent months rebuilding my game.

Again the issue here is NOT that scaling is fundamentally incorrect. It’s that if your scale ambitions are so high, and you’ve gone so wide so fast, well then, you’re left with a “bridge to another bridge” – specifically what the market is beginning to reject.

Megarounds Causing a Loss of Fundamentals

The logic of today’s growth financing market operates as follows:

  1. The majority of markets operate as Winner Take All where outsized returns accrue to only a single dominant player, as outlined by Wealthfront co-founder Andy Rachleff in Demystifying Venture Capital Economics.
  2. Investors are therefore highly incentivized to create unicorns/decacorns/gorillas/whatever you want to call them.
  3. Cost of capital is at historically low rates, to the point of even negative interest rates in Europe – “flabbergasting” Berkshire Hathaway investor Charlie Munger. For reference negative interest rates actually “punish banks that hoard cash” in order to force lending.
  4. Therefore, focus is unilaterally on scale and growth ahead of fundamentals, with the theory being that once customers are locked in (either enterprise or consumer), the model can be refined.
  5. Because companies assume their competitors are optimizing for scale (i.e. trying to raise mega-rounds) they also raise mega-rounds.
  6. The convergence of multiple mega-rounds inflates cost structures/weakens economics for both companies forcing them to raise further funding.

From Bill Gurley’s Investors Beware:

The very act of dumping hundreds of millions of dollars into an immature private company can also have perverse effects on a company’s operating discipline. The only way to use the proceeds of such a large round is to take on massive operating losses. Historically, as a company neared an IPO level of revenues (say $50-$100mm), investors would expect convergence toward profitability. As these late-stage private companies digest these large fund raises, they are pushing profitability further and further into the future, as well as the proof that their business model actually works.

While the high level logic of the megarounds is sound: that unicorns should be prioritized for outsized returns – there appears to be an absolute uncertainty surrounding how far to scale and at what cost. Is 5 markets sufficient? 15? 50? 100? There will always be more potential ground to cover. Gurley’s point is that the recent spate of continual growth financings is akin to not knowing when to take some money off the table. The market may well give you a loan to double down – but should you?

Consumer Companies 

As noted above, the carnage (for the moment) appears directed at consumer companies. What’s disconcerting as a consumer investor is that it’s not simply social or media plays devoid of revenue at all, but even revenue generating transactional models such as Homejoy, Goodeggs, or Fab. I don’t have a good answer yet for why this is. If sales driven enterprise software companies are exempt from current market concerns, revenue generating consumer companies should also earn some credit. Maybe it’s about margins or delusions of Long Term Value? Unclear, but worth more consideration.

It’s also hard to know whether this is a coincidence of sample size, a temporary pause in the markets as investors get over-saturated with opportunities/deals (recall that the IPO markets entirely closed in the spring of 2014 for a month around the time was looking to go out – then boomed again), or a fundamental shift in investor perspective.

All that said, one thing is clear: from the people I’m talking to and the signs I’m seeing, it really feels different right now. Only time will tell.

Copyright © 2014. Created by Meks. Powered by WordPress.