Andrew: Hey, everyone. My name is Andrew Warner. I’m the founder of Mixergy.com. I am so freaking proud to bring this interview to you.
Joining me today is a man who founded one of the top legendary firms in all of tech. He is the cofounder of Benchmark, it’s a venture capital firm that invested most recently in companies including Uber and Snap. Historically, they’ve been known to have successes going all the way back to eBay and Juniper Networks.
Here he is on Mixergy talking a little bit about Benchmark and also about his new company. It’s called Wealthfront. It’s an automated investment service that’s allowing people to invest in a really smart way. I think younger and younger people are going to–in fact, they already have gravitated towards it. I’m excited about it too. His name is Andy Rachleff and I’m so proud to have him on here.
I’ll say that the two sponsors for this interview are the company that will help you hire great developers. It’s called Toptal. The second is a company that got me a beautiful design. My heart is exploding with pride from it. It’s called DesignCrowd, but I’ll tell you more about those later.
Andy: Thank you for having me.
Andrew: Which of the investments–and there’s a long list–are you proudest of having made?
Andy: As a firm or myself?
Andrew: Interesting. I was thinking as a firm, but why don’t you broaden it out, including yourself too?
Andy: Well, it’s hard to pick. They’re like your children. So, as a firm, I think we’ve been really fortunate to make great investments and the team that’s making the investments today I think is doing an even better job than those of us who started the firm. As you mentioned, companies like Snap and Uber, Twitter–it’s just a fantastic list.
I’d say personally my two favorites were probably Juniper Networks, which really changed networking and a company called Equinix, which is a multi-billion dollar revenue company that no one’s ever heard of that actually makes the entire internet work.
Andy: Well, they are the peering centers or the hosting centers where all of the networks that comprise the internet interconnect with one another and where internet companies can connect their content to those networks. It’s a network effects business that is incredibly profitable and much, much larger than anyone would ever know.
Andrew: I asked people–I asked venture capitalists what they admired about Benchmark and what I should talk about. Here’s what they said. They said things like, “Ask about the transition.” This seemed at least on the outside like a really smooth transition. “Ask about the shift away from Sandhill Road to San Francisco.” You guys made that move. Does Benchmark even have an office in Menlo Park?
Andy: It’s in Woodside, the town next door.
Andrew: Okay. But the main office is San Francisco, right?
Andy: No. They’re co-equals.
Andrew: Okay. “Ask about why they didn’t get big.” So many other firms that started back then who succeeded got big. And about your opinion on the bull market–I actually heard you tell Jason Calacanis in an interview a while back that you were still a believer in this market, meanwhile Bill Gurley, a partner at the firm, I’ve got tons of screenshots of him saying there is a bubble and he’s worried about it. I’d like to ask you about all those. Then I want to ask why Wealthfront.
Andy: I can interpret Bill’s comments for you.
Andrew: You could?
Andrew: What is it?
Andy: You want me to start there?
Andrew: Yeah. Let’s start there.
Andy: Well, I think that Bill feels very, very strongly that companies would be better served going public than they would raising money privately. Even Mark Zuckerberg, who was a vocal opponent to going public has now changed his tune and said that he would have been much better served if he had gone public earlier because it added a level of discipline that really made Facebook better.
So Bill is of the belief, as am I, as I think are most very good venture capitalists, that companies benefit from going public. And by the way, it keeps the entire venture capital world going. If companies don’t go public, we can’t generate the liquidity for our limited partners to keep raising funds. Why should they give us money if we never get liquidity?
Andrew: Isn’t he also saying that–I don’t remember the details of this, but I did hear him in an interview with Recode, I think it was, with Kara Swisher, saying there’s just too much money out there and that’s part of the bubble.
Andy: Well, there’s always been too much money chasing too few deals. I graduated business school in 1984 at Stanford. I remember in 1983, Don Valentine, the founder of Sequoia, lecturing our class on how there was too much money chasing too few deals. That has always been the case. I don’t think Bill was talking about a bubble. Bill thinks that it doesn’t make sense for people to be financing companies privately the way that they are. He thinks that companies would be far better served going public.
Andrew: What about this–in the bubble of the late ’90s which exploded around 2000, you said that you believed the smart people knew that it was a bubble and they knew that it still made financial sense to be in there as long as you got out before you got into trouble, that you were aware of it back then. Is there also an awareness right now internally that you have that, “Look, this is a little bit too much, but I can’t not do anything and I’ve got to jump in there.”
Andy: I think this is a radically different time.
Andrew: I think I just lost you there for a second, Andy. Radically different time, you were saying, yes?
Andy: Unfortunately, I can hear you just fine, but your video just stopped.
Andrew: Okay. It should come back. Is it back?
Andrew: No. I’ll call you right back.
Andy: There you are. There it is.
Andrew: Yeah. You were saying it’s a radically different time, yes?
Andy: It’s a radically different time in that, if you remember in 1999, companies were going public that were still in beta. They didn’t even have revenue. Many companies were going public based on revenue momentum with negative gross margins. I don’t know about you, but I think I could build a pretty good business if I handed people money to take my product.
Andy: So what’s going on today to me is nothing like that. You have companies that are going public now that have hundreds of millions of dollars of revenue and are cash flow positive. Valuations are way up. I’ll agree to that. But these are much, much more substantive businesses. So there’s no comparison in my mind between what’s going on today and what happened in the late 1990s.
Andrew: Okay. Let’s go on to the other point, which was the transition, which was really smooth. You’re not with–
Andy: Are you talking about the transition of the partners of the firm?
Andrew: Yes. You’re not a partner anymore, right?
Andy: I am not.
Andrew: You’re not a partner.
Andy: I have the title of Alumni Partner.
Andrew: That’s the title?
Andy: I think that’s my title.
Andrew: How did you make the transition so smooth?
Andy: Well, when we started the firm, we were very unusual in that our number one goal as a group and what unified the people who started the firm was we wanted to build the best firm in the business. Now, very few people in the venture capital business aspire to be the best because we don’t need to be the best to make a lot of money. We don’t really care about the money. We cared about the position. So we were riveted on trying to build the best firm in the business.
So we did something that we advise our startups to do, which is figure out who your closest competitor is and then turn their greatest strengths into their greatest weaknesses. So when we started in 1995, by far the leading player in the early-stage, high-tech venture capital world was Kleiner Perkins Caufield Byers. Their two greatest strengths were they had the world’s greatest venture capitalist in John Doerr, and they were known for their keiretsu, so their network of portfolio companies.
Kleiner’s reputation back then was if you become part of the Kleiner platform, you have a tremendous advantage in working with the other Kleiner portfolio companies. So we tried to turn those two advantages into disadvantages. How do combat a great individual with a team? So we decided that we had to build a fantastic team. The best way to build that team was through an equal partnership. This is communist capitalism, what we used to refer it as. No one had ever done that before, I think, because of greed.
So, in a traditional venture capital firm, you have a hierarchy, that the more senior partners own more of the economics. The more junior partners own less. But the dirty little secret is the junior partners generate all the returns. So we said that we wanted to build an equal partnership in order to attract the best talent.
The idea was that in future years, if someone had a choice between joining us as a partner or joining us as a partner or joining another firm as a junior partner, they’d rather join us because they’d be an equal. We think that’s played out. So the idea of the always equal partnership was critical to combat the superb individual.
Now, the other partners at Kleiner at the time were very, very good, but entrepreneurs were very disappointed when they didn’t get John Doerr and John couldn’t do every one of their deals. He didn’t have enough capacity.
Andrew: I never know how to pronounce the word–the network.
Andy: So that’s number two. So the positive is that you have a leg up in working with the Kleiner companies. The negative was a lot of entrepreneurs felt pressured into working with the Kleiner portfolio, whether they wanted to or not. So, we positioned against that by saying, “You’re the star. We’re the stage hand.”
Kleiner often took the title of chairman in their companies, which was a little off-putting to the entrepreneurs because it was their companies. So we made a really big deal about, “We’re here to help you get what you want accomplished. You’re not here to serve our portfolio.” After all, a lot of entrepreneurs start companies because they don’t want to be told what to do. So we thought this played really well there.
So, back to the equal partnership, the blood brothers pact that we made when we got started was that the only way an equal partnership would work was if any of the partners got to the point that they weren’t willing to put in 110%, they had to opt out. I mean completely out because this is not a business that lends itself to part-timers, not if you want to be the best. If you want to do well, you can have part-time partners. If you want to be the best, you need everybody killing themselves to win.
So our attitude was if you’re not willing to go 110%, you finish your portfolio and at the next fund, you get zero equity. So that means as a founder, there’s no goodwill. My goodwill is my legacy. And that allowed us–so, if you didn’t do this, the pie would keep on shrinking for–if you kept adding more and more partners in an equal partnership, there wouldn’t be a great economic incentive.
But if everyone opts out who’s no longer working 110%, then there’s plenty of pie left. We were able to recruit first Dave Beirne and then Bill Gurley and then Peter Fenton and Mitch Lasky and then Matt Cohler and Eric Vishria. So we’ve been able to recruit just superb people who are arguably better than we were, and they’re doing as good if not a better job. So I think the system works.
Andrew: Does that then put pressure on them to ask you to leave because you’re collecting the same–
Andy: No, you never ask. If you have to ask someone to leave, they should be fired.
Andrew: So then if you left, it wasn’t because they said, “Hey, we’re producing so much more than you.” It was you thinking, “I’m not going to kill myself anymore.”
Andrew: That’s it?
Andrew: Do remember when you said that’s–
Andy: Doing the right thing.
Andrew: That’s a hard thing to decide. Do you remember when you decided it?
Andy: When I reached the point that I would rather go to one of my kid’s ballgames than make another call.
Andrew: I see.
Andy: We spent the first three months together discussing culture, not strategy, because culture endures and strategy changes.
Andrew: I see.
Andy: We had been heavily influenced by a book called “Built to Last.” It was written by a Stanford Business School professor and lecturer. It talks about how the companies that endure–and that meant a lot to us to build a franchise that would endure because three of the five founders came from two of the top five firms, TVI and Merrill, Pickard, Anderson & Eyre, that didn’t endure. So we chose an architectural name because we wanted something that would endure.
Andrew: I see.
Andy: Our legacy meant more to us than the economics. Our market position and legacy meant a lot more to us. So it was genuine. Anyone who joined the firm, if it wasn’t important to them to build a number one firm in the business and continue this culture, then they wouldn’t have been hired no matter how great an investor they were.
Andrew: Why not go bigger then?
Andy: It doesn’t scale.
Andrew: It doesn’t scale. What would have happened if you tried to go bigger?
Andy: The problem with venture capital is the way that you make money is by taking risk. Without risk, there is no reward. That’s something that I think distinguishes the premiere firms from everybody else. They know which leaps of faith to take. But you have to take risks to get reward. You have to bet on companies that are contrarian at the time you invest. Later on, you say, “Of course that made sense.”
EBay, until eBay went public, our colleagues in the industry said, “Beanie Babies, really? That makes no sense to me?” And if you look at all of our big, big winners, they all had a component to them of that contrarianism. So you need to take risk. The more people you have around the table, the less willing as a group you are to take risk.
Andrew: Why? Because someone can say, “That’s too risky for me?” and then opt everyone else out?
Andy: Well, you get more and more people–it bogs down the conversations. You can’t move this quickly.
Andrew: I see.
Andy: So, again, if we wanted to maximize our cash flow, we were the first to build international funds. What we realized was it distracted us from what we wanted to do, which was early stage–be the best at early stage investing in the US. We made a very nice living doing that. We can pass that on the extra money from overseas funds. We didn’t need growth funds. We didn’t need seed funds. We wanted to put all of our wood behind one arrow head to build the best early stage firm in the business.
Andrew: When you say the best, what does that mean? Is it defined by a metric of success?
Andy: It isn’t. I think our returns speak for themselves. I can’t imagine over the last 20 years any venture firm having a higher return that we did. Our first fund, I think, was the number one performing venture fund of all time. But best in our minds is defined by what the entrepreneurial community thinks.
Andrew: But how do you measure that? How do you know that they. . .
Andy: It’s pretty clear. The fact that you introduced me the way that you did I think speaks volumes about that.
Andrew: Yeah. I can’t define it either. But I do know as I was bringing up your name, as I was bringing up your firms name, as I was bringing up your legacy, definitely people are in awe and appreciate it, but I get it. I feel like we’re in a world of metrics though that maybe you guys had some metric and you said, “This is what we need. We need to be in the top five IPOs every year,” whatever.
Andy: You know something? These numbers, it’s hard to measure that. Just like within our firm, we knew that we would not have equal performance even though we have equal economics because luck plays a big role in all of it. As long as each of us was making the same level of effort and had the same kind of impact on people, we thought that would further the reputation.
Andrew: Let’s talk San Francisco. That seems to have been a big thing, right? Or am I making too big of a deal out of it? I’m trying to read your face to see if maybe I’m thinking this was more than it was.
Andy: I don’t think it was a really big deal.
Andrew: It wasn’t?
Andy: When I graduated from business school, the vast majority of the venture firms were still in San Francisco. The last one to move from San Francisco to Melo Park was Kleiner Perkins.
Andrew: Is that right?
Andy: Yeah. They were the absolute last.
Andrew: I remember coming to San Francisco and then saying, “I’m going to go down. . .” for people that don’t know, it’s just like an hour drive south of San Francisco where you get to see the venture firms right now, and you get to see companies like Google and LinkedIn and all the rest. You’re saying it used to be here in San Francisco. Then it became more of a South Bay thing.
Andy: Now it’s moved up. My take on it is that in the early days of the business, it was a San Francisco thing because a lot of the players came from financial backgrounds, so they might have worked in the Financial District. Therefore, the firms were based in the Financial District.
They all started to move down to the Valley to be closer to the companies because they didn’t like the commute. Every day you had to commute back forth to get to the company. So they all started moving down to the Peninsula investing in companies in the Valley. And guess what? Of late, most of the companies are starting in San Francisco. So what do you do? You open your office in San Francisco so you can be closer.
Andrew: And that’s a harder move though because you guys moved to a pretty grimy part of San Francisco. I’m in the Financial District. This is really nice over here, frankly. I can’t get a sandwich for less than $12. You moved into a grimier part of San Francisco than I did, and it’s a harder move because South Bay is a nicer environment. You get to see more sun. You get more space.
Andy: Where are the entrepreneurs?
Andrew: Right there in the grimy part. That’s what it is. You guys said, “Look, we are well off enough to be anywhere. We’re choosing to be in a place here that’s a little bit tougher to be in because we want to be closer to the entrepreneur. That’s who we are.”
Andy: The only thing that matters is the entrepreneur. The limited partner doesn’t matter. No one matters other than the entrepreneur.
Andrew: Makes sense. All right. Let me talk about a sponsor. Then I also want to ask you–I forgot to intro this–your Stanford class and product market fit. I want to understand what having gone through all these companies what you understood and then I want to get into Wealthfront because I’m really excited about Wealthfront. I had no idea this was even a possibility. I think for me it’s an especially compelling company because I’m a bit of a chicken when it comes to investing my money. I like to take risks, but not with the money that I made.
All right. But first, I’ve got to tell people about a company called Toptal. Do you know about Toptal or am I about to–
Andy: I do not.
Andrew: You do not? Oh, this is wonderful.
Andy: I’m learning too.
Andrew: Here’s the thing about Toptal. These guys decided there are a lot of companies trying to hire. The problem with hiring is it takes too long. The problem with hiring is it’s a very expensive process. It’s drawn out. They said, “You know what? We’re going to put together a series of really challenging tests for developers. We’re going to make it really hard for developers to actually get past our whole sequence of tests for them. If they do, they’ll be in our network of developers.”
So when a company needs to hire an individual developer or a team of developers, anything in between, they come to Toptal. They talk to a real human being. They say, “Here’s our culture. Here’s how we work. Here’s the kind of developer we need. Here are the languages we’re working in.” Toptal goes into their network and they bring the best of the best and they make a match. If it’s a match, you often get to hire them, Andy, within a day or two. You get to startup with them.
So that’s the whole ideas behind Toptal. They actually raised money from Andreessen Horowitz and they’ve just been growing beyond that. They went from just developers to designers. Now they’ve got a whole division that lets you hire MBAs, so if you need a consultant to help with finances, help you think through your business, they’ve got that whole thing.
They’ve been with us for a long time here at Mixergy because companies are actually hiring from Toptal and they are sending me thank you notes. They’re sending Toptal thank you notes and they continue to keep hiring from them. So, I’m going to continue to read ads from them. Also because it was started by a Mixergy fan, I’ll tell you they’re offering Mixergy listeners something really special you can’t get anywhere else. I’m going to read it exactly from your website and then give you the URL where you can take advantage of it.
The deal is Mixergy listeners are going to get 80 hours of Toptal developer credit when they pay for their first 80 hours. That’s in addition to a no-risk trial period of up to two weeks. Again, it’s top as in top of the mountain, tal as in talent go to Toptal.com/Mixergy to get that.
Andy, the class that you taught, how much was product market fit a part of that class?
Andy: Well, I taught a number of courses at Stanford.
Andy: One of the courses that I helped create is called Aligning Startups with Their Markets. It’s all about the importance of product market fit to the success of a startup and how you go about optimizing it.
Andrew: What’s the importance of product market fit? Why is that something you’ve talked about so much?
Andy: Well, I think it is the absolute key to success. So the pithy way that I try to explain this is that when a lousy management team meets a great market, market wins. When a great management team meets a lousy market, market wins. When a great management team meets a great market, something really special happens.
Andrew: I see.
Andy: If you look at the vast majority of very successful startups, they didn’t have the world’s best management teams in the early days. But they happened to have conceived or pivoted into more likely an idea that really addressed an amazing point of pain around which consumers were desperate for a solution.
Andrew: Can you give me an example of a pain that consumers were desperate that then became a big business?
Andy: Name a company.
Andrew: I’m going to name Google for a reason.
Andy: Okay. So Google, let’s talk about their business model. So when they ultimately decided to do the text ads, the alternative in the market at the time were display ads. The only way you could advertise on the internet were display ads. Because they were sold through a direct sales force, Yahoo required a minimum order buy of $10,000 per month.
And back in the day, you probably didn’t have a designer on staff, believe it or not, designers were not an important function in internet companies back then. So you had to pay a graphic designer $2,000 to $5,000 to design the ad. So the minimum you were in for was $12,000 or $15,000. Startups couldn’t afford that. So they didn’t advertise on Yahoo or display networks.
When Google introduced text ads, now you could buy an ad for $1, and there was no sales force and it was self-service and it would go up immediately. Well, guess who the original customers were for Google text ads? They weren’t big companies because a picture is worth $1,000 words, “Why would I advertise with a six-word text ad?” The original customers were the people who were desperate to use internet ads but couldn’t afford them–startups.
Andrew: I see.
Andy: And once Google proved the efficacy of that, then they were able to expand into larger companies.
Andrew: Do you think they understood that that was the problem the way you just described it, or did they just hear–I think I read from Bill Gross that this was the way that GoTo.com was doing it, you should copy it and they said, “Let’s copy what’s working for someone else.”
Andy: He didn’t want them to copy it. It destroyed him.
Andrew: He didn’t say copy it. I think it was like a partnership or something that brought it up? No.
Andy: They just copied it.
Andrew: They just copied it.
Andy: They just copied it and used it to their advantage, except they did it direct, whereas Overture, which was what Bill Gross’ company was renamed, did on an OEM basis for other websites.
Andrew: Right. You didn’t go to GoTo.com. You went to someone else’s.
Andy: Here’s another example, Airbnb. When it started, it was purely accidental. One of the three founders had actually moved out of their apartment in San Francisco and the two remaining what became founders needed some money to make their rent. So, a design conference came to town and they rented out Nate’s room, and they were amazed at the amount of people that were willing to pay to rent out a room. So they tried to build an event-based business, a service around events.
Andy: They found some data that ultimately caused them to pivot into non-event based business. So you often stumble into your product market fit, and what we’ve found, my teaching partner and I, Bill Barnett, have found is that serendipity plays a role in finding product market fit but the process to get to serendipity is incredibly consistent. So what we do is we teach what that incredibly consistent process has been.
Andrew: So, just to be clear, you’re saying in the case of Google, it’s not like they understood that companies had a problem of spending too much money on designing the ad, spending too much money up front and they said, “We’re going to come up with this alternative. It’s not like they understood that pain. They just kind of lucked into it? Is that right?
Andy: I think luck is too strong of a word.
Andrew: Luck is not the word, but they happened into it.
Andy: Steve Blank wrote an amazing book called “Four Steps to the Epiphany” that really started this whole idea of a customer development process. And then Eric Ries wrote the equivalent of the New Testament, which was a much more readable version of “Four Steps to the Epiphany,” called “The Lean Startup,” which is now an incredibly popular book.
So what Steve came up with was an, I think, absolutely brilliant way to help startups. Basically what he said was startups should apply the scientific method just like scientists do. You should start with a hypothesis, test the hypothesis, prove it and then move on. If your hypothesis cannot be proven correct, then you iterate on the hypothesis.
Steve further observed–we backed Steve three times over the years in my previous firm, so I knew him really well. He had observed that in contrast to what most people think entrepreneurship is, which is evaluating a market to try to find the holes or the problems and developing solutions of those problems, that leads to very mundane outcomes.
The truly great technology companies are the exact opposite. They are the result of an inflection point in technology that allows the founder to conceive a new kind of product. The question then is, “Who wants to buy my product?” So you start with the product and try to find the market as opposed to starting with the market to find the product.
Andrew: So you’re saying it’s not even finding the pain. It’s not even finding the market. It’s finding new technology and say, “What can I apply this to?”
Andy: And then figure out who wants that?
Andrew: And then what’s the iterative process there? Doesn’t Steve Blank say, “Talk to your customers, test and see,” same thing with–
Andy: What he and Eric Ries have come up with is an idea that first you need to define and test your value hypothesis and then only once proven do you move on to what’s known as a growth hypothesis. The value hypothesis defines the what, the who and the how. What are you going to build? Who is desperate for it? What’s the business model you’re going to choose to deliver?
Andy: Until you prove your value hypothesis, you waste money to spend money trying to acquire customers. Unfortunately, most people try to get the growth before they prove the value hypothesis. You don’t want to get the cart ahead of the horse. That was one of his key concepts. Now, within the value hypothesis, people think, “I should iterate on the product until I find something people want.” No. You stick with the product. You figure out if the first group I approach isn’t desperate, then I’ll try to find a different group that’s desperate.
Andy: Now, most people don’t do that. Most people just keep on trying more people to see somebody’s got to want it. The first class in my product market fit class I ask, “Should everyone like your initial idea?” The answer is absolutely not, because if they do, then the only reason they do is they’ve been conditioned to like it by someone else. Means people aren’t desperate for it because somebody else is serving it.
Andrew: Do you have an example of a desperate need you saw that didn’t seem obvious at the time?
Andy: I’ll tell you Wealthfront. How about an example of Wealthfront?
Andrew: Yeah. Let’s talk about Wealthfront then.
Andy: So the vast majority of investors in the United States are delegators versus do-it-yourselfers. They want somebody to manage their investments for them. You hear more from the do-it-yourselfers because they’re more vocal.
Andrew: These are the people who are on E-Trade. They’re the people on Charles Schwab, etc.
Andy: Exactly. But they’re about a quarter of the audience, and about 75% of investors prefer to have someone do it for them. But in order to afford a financial advisor to manage your money, you typically need a minimum of at least $1 million.
Andy: So what do you do if you have $100,000?
Andrew: If you have $100,000, then don’t you put it into a managed fund, which is not the same.
Andy: What’s a managed fund?
Andrew: Isn’t a managed fund where I say, “I want to invest in this kind of company,” and there’s someone who will manage it? Am I wrong?
Andy: Like a mutual fund?
Andy: So what kind of mix of mutual funds do you put together?
Andrew: Right. Okay. Then I pick it out myself and I go to a financial advisor–
Andy: For a financial advisor, you need $1 million to do it for you.
Andrew: Or I Yelp someone and I find a guy in a small office who will help me figure it out, or I get a broker. None of that. Isn’t that the way it was done, that somebody who wanted to not manage–you tell me.
Andy: So you’re left out.
Andy: If you’re less than $1 million, you cannot get your money managed well.
Andy: So what we did is we came in with a solution for people with less than $1 million who wanted to invest like multimillionaires. So, basically, what we did was we’re taking all of the services that are offered by private wealth managers–these are really high end financial advisors who serve people with minimums of $5 million, $10 million or $15 million and through software, we make their services available to the masses.
Andrew: And is it an actual–sorry, it is a professional on the other end of it or is it software?
Andy: What we’ve done is we have a group of phenomenal PhDs that basically clone services that are delivered through an individual. But software does a much better job of these services than people can.
Andrew: How did you know this was a problem? There’s no one who’s walking around going, “I can’t get someone to manage my money because I don’t have $1 million.” They’re not complaining about them vocally. They’re not going on Quora and asking, “How can I have someone manage my money if I have less than $1 million?”
Andy: Actually, they do, but that wasn’t it.
Andrew: What did you do?
Andy: Here’s how I came up with the idea. Great ideas find you, you don’t find them. If you sit in a room trying to figure out, “What company should I start?” then by definition you’re starting with the market, trying to come up with the solution and that leads to mundane ideas.
Just let me give you a framework for thinking about that. My investment idol is a guy named Howard Marks, who founded a company called Oaktree, which is one of the leading distrust debt investors in the world. Howard is famous for his quarterly letter to his investors as he is for his fantastic returns. All his letters are based on the same framework. Howard describes the investment business with a two by two matrix. I think this matrix describes entrepreneurship as well.
On one dimension, you can either be wrong or right. On the other dimension, you can either be consensus or non-consensus. Clearly, if you’re wrong, you don’t make money. What most people don’t realize is if you’re right in consensus, you don’t make money because all the returns get arbitraged away. The only way to make outsized returns is to be right and non-consensus.
Andy: So starting with the market to try to find a problem, everybody can do that. That’s a right and consensus approach to entrepreneurship. Starting with an inflection point in technology which allows you to build a product and find a solution, that is non-consensus. If it works, it works big. That’s where the great venture capitalists all focus, back to the point I made earlier.
So, in my case, I was sitting in a Penn endowment meeting. I had retired from Benchmark in 2005. I have a life well beyond anything I ever could have imagined. I wanted to give back. I decided to teach at my grad school alma mater and went on the board of trustees at my undergrad school, University of Pennsylvania. My wife and I started an innovation cancer research funding initiative. One of my responsibilities as a paying trustee was to sit on the investment board. I think we have the eighth largest endowment in the U.S.
All the premier university endowments are the best managed large pools of capital in the world. This is very well understood in the investment community. As luck would have it, one day they start telling us about how they did what they did. They were doing it with spreadsheets and arcane tools.
I don’t know why, but it sparked this memory that I had that over the years, I had recruited many people to my portfolio companies who went on to financial success. They would often come to me for investment advice. I could never tell them to do what I do because they couldn’t include the minimums associated with the investment products and services. Even those who had made $1 million or $5 million still couldn’t afford access to the best products. That really bothered me.
I was sitting in this room. I knew about these new APIs that were being created by brokerage firms and I thought, “Oh my god, through software, you could do an 80/20 on what the university endowments do, thereby solving this problem that I’ve been hearing about for ages. So I decided to go and try that as a hobby, and it turned into a business.
Andrew: Aren’t you there in that case finding a problem that’s percolating, that bothered you, that gnawed at you for a long time and saying–
Andy: But I wouldn’t have done it if I hadn’t known about the inflection point in technology.
Andrew: I see.
Andy: No inflection point, no opportunity.
Andrew: How did the APIs fit into this?
Andy: Well, our service was not possible until you could fund an account electronically, sign up for it electronically and trade it electronically. If we had to have people helping you with all of those things, then we couldn’t charge a fee that’s a tiny fraction of what a traditional advisor might charge.
Andrew: I see. And so you had this idea–
Andy: Without software doing everything, we couldn’t have lowered the minimum to $500. So we’re giving you what someone who has a minimum in excess of $1 million does for a minimum of $500.
Andrew: So you want someone who has $500 to come and work with you guys, to put their money into Wealthfront? That’s not too small for you?
Andrew: What they do is they go in and–
Andy: Not too small for software. That’s the beauty of software is how scalable it is.
Andrew: Yeah, I guess it is. I always think of someone who has $500, at least in the financial world, as just being too little to be worth–
Andy: Because you can’t afford–you don’t have the time to spend on their account.
Andrew: What about customer service even?
Andy: They don’t need service. If you’re completely transparent in what you do, if you charge a fair and low fee and you make everything obvious–do you need to talk to somebody to get an Uber ride?
Andy: Do you need to talk to someone to rent an Airbnb room? Do you need to talk to someone to buy something on Amazon? No. Let me tell you–do you need to talk to someone to book a flight? We used to have travel agents.
Andrew: In fact, if you want to talk to someone about a flight, you can’t get to them.
Andy: I know. We offer client service, but we make it incredibly easy. Actually, software does a better job than traditional investment advisors because it does things continuously that they can only do periodically.
Andrew: All right. I want to ask you about something that you told me before we started that I was surprised you were so open about. We’ll get to that. Then I also want to ask you about your desk, which I’ve heard is really different and interesting and I’ll ask you about that. Then also the evolution of this company, of Wealthfront.
But first, I should tell people about DesignCrowd. If you’re listening to me–in fact, if you’re looking at me–Andy, you would not look at me and say, “Andrew is a design nerd in any way.” Look at my haircut. I buzzed it this morning, right? I like that you said, “Andrew you’re doing video? Let me go and position my camera so I have the oars in back of me instead of the half of whatever you had, the clock behind you,” right? You cared about it to that degree. Design just makes me so anxious. I can’t even articulate what I want to designers, let alone create it.
So the cover for my podcast was just this ugly thing that I knew was bad. I know enough about design to know it’s not good. But I didn’t know how to articulate to a designer what I was looking for. I was intimidated, frankly, of even using my sponsor. I know that DesignCrowd had helped people, but I was intimidated about it.
And then one Friday night, my wife was out. I was sitting at home. I said, “I don’t feel like doing anything.” I was watching “Shark Tank” because one of the sharks is going to be on Mixergy. I said, “Let’s just go and do it.” It was just like one box. I said, “I have some opinions. I really hate when you can’t see what the podcast is about.” I wrote that, “I want a design that looks like, where you can read the title of the podcast. I don’t need the logo to be so big.” So I wrote that.
I said, “I really like these designs that have one big bold color because in the iTunes Store, there are tons of different cover art, you can’t figure out what’s going on in some of these things. It’s too small. “So I started filling it out and I said, “You know what? I actually have opinions.” I hit submit and I said, “Let’s see what happens.”
Well, because they’re a sponsor, I used a URL they’re giving our audience. It was only like–forget what the exact price was. It was super cheap. I said, “All right, you know what? I’m just going to put my credit card down.” I put my credit card down. I hit submit. I forgot about it. I went on to “Shark Tank.” Monday I come in, I have an assistant who goes through my email with me because I get so much email. I get an email from DesignCrowd. “You’ve got a bunch of designs.”
So I click over and for someone like me, this is–for someone like me to have a design that looks as good as any one of these is shocking. It’s like an ugly guy who suddenly gets to date a beautiful woman who’s going, “Really, me?” I have that moment. I was so excited. I started to like star the ones I liked. I started to give feedback to them. There was one I asked for in green they gave me in yellow because I asked for a variation. So, beautiful.
Listen to me, if you’ve heard me talk about DesignCrowd before and now you’re seeing this excitement, it’s because I love good design but I don’t know how to get to it and now I got to it because of DesignCrowd. It cost me very little. I forget the exact number. I don’t want to get it wrong, very little because they’re offering Mixergy people $100 off.
All you have to do is go to DesignCrowd.com/Mixergy. I believe it’s $100 off. It’s a big discount. Yeah. Save up to $100 on custom design. Go to DesignCrowd.com/Mixergy. I’ve posted in on Facebook. Others now have gone to them and showed what they got from DesignCrowd.
You’re going to be as excited as I am and they are. I promise you. Go to DesignCrowd.com. Designers from all over the world, each one giving you a design, you get to give them feedback. They then go and rework it. Other people jump in and suddenly you have dozens of designs. In my case it was 56 so far. Then you pick the one that you want and you pay for it. Beautiful. DesignCrowd.com/Mixergy.
Here’s the thing, you told me before we started–I dig, by the way, that I get to watch you as I do this. I saw your smile as I was getting excited. I said, “I’m on the right track here with this.” It’s kind of weird to record an ad. I know Jason Calacanis who we both know, he records his ads sometimes just into a camera. It’s a little tough. I like to have a person there see if I’m on the right track or not.
Anyway, I found an old video of you with Kara Swisher back when she was holding her phone up like this interviewing about this company, Wealthfront. But it was called something else at the time. What was it? Sorry?
Andrew: What was the origin of Wealthfront before Wealthfront? What was going on there?
Andy: This is a great example of what I teach in product market fit. This has been a wonderful laboratory to really work through my ideas. So the original idea from the Penn Endowment was premiere university endowments are able to identify investment managers who are likely to outperform the market. But in order to do so, they need access to all of their trading data to be able to do certain types of attribution analysis that mutual funds don’t allow because they’re opaque.
So our thought was that if we could apply this Ivy League endowment to investment managers’ data, then we could actually make–we could help people pick ideal managers and we could bring the minimums down from $1 million to $10,000.
Andrew: I see.
Andy: So we built this marketplace of investment managers. We attracted something like $30 million over a year and a half. Now, we had doubled in the last six months, but we only had about 10 months of cash left. Having been a venture capitalist, I knew that we were not going to raise more venture capital doing this, and we couldn’t get to break even on the path we were pursuing.
So I had really asked a number of people in the company to reach out to clients to non-clients, people who hadn’t signed up to find out why they hadn’t. An interesting thing is that this is a generational thing that a lot of young people don’t like talking to prospects. They like looking at the behavioral data. They like emailing. They like surveys. But it’s uncomfortable to actually reach out to someone and ask, “Why didn’t you want to use our service?” So, after asking a bunch of people in the company to do it, I finally had to do it myself.
I got incredibly consistent feedback which was, “We’d rather that you manage our entire portfolio adequately and inexpensively than a portion of it superbly.” Our old service was really only appropriate for your US stock allocation, which is typically about a third of your portfolio. I thought, a) this is incredibly consistent feedback and b) it’s a lot easier to do than what we were doing. So we decided to pursue the Lean Startup methodology. We started with a concierge approach, where we offered the service people paper and pencil to see if people were desperate. They seemed to be. We then built a prototype. When people started saying, “Please take my money,” then we knew it was time to launch. It worked from the beginning. Now five years later we have more than $5 billion under management.
Andrew: $5 billion?
Andrew: And that number just keeps growing and growing. I go back in time to look at old articles. It’s like, “You’re $100 million,” and then I saw an article saying, “Well, $1 billion would be a big milestone,” then $1 billion you hit, now it’s $5 billion.
Andy: I think we had more than $230 million of deposits in January alone.
Andrew: In January?
Andrew: Wow. So let me just break that down. You made the phone calls yourself because the people who are working with you just didn’t feel as excited about doing it.
Andy: No, it wasn’t that they didn’t feel excited. They weren’t comfortable.
Andrew: Comfortable. I actually was trying to soften it because I didn’t want to put them down. I’m surprised that someone wouldn’t feel comfortable wanting to talk to a customer, but maybe I shouldn’t be. What did you understand? How did you ask them questions? What did they tell you that let you understand that they wanted you to manage all of their money well and that they had other money somewhere else? What was that whole question process like?
Andy: Well, it was pretty straightforward. We don’t–one of the things that we do that’s unique in the financial services industry is that we don’t ask for your contact information until you open an account. We actually show you what we’re going to give you before we ask for any identifying information.
Andrew: So I can fill out not a survey, but I can tell you how risk tolerant I am, etc. and then I still get some information back and only afterwards to you as for a contact.
Andy: Yes. Today, we even tell you what we will buy on your behalf. If you want to take that and do it yourself, you’re welcome to. Do-it-yourselfers are never going to become clients anyway, and a delegator would gladly pay us a modest fee to do it for them. So it’s sleeves off of a vest.
Andrew: Okay. So then what was going on in those phone calls that helped you understand what they want you to create?
Andy: So what we did was the only contact information we had was for people who started an application and didn’t complete it.
Andy: So I reached out to the people who had started an application and chose not to fund the account. First I emailed them, telling them what I would like to do. The fact that I was the cofounder made it, I guess, more credible. They were willing, some portion of them were willing to talk. I talked to about 30 of them. The message was just unbelievably consistent as to why they ultimately didn’t pull the trigger.
Andrew: They have all this other money, and unless you take it all, they just don’t want to have somebody handle a small portion of it, a third or so. That was it?
Andy: Well, the value proposition was that we could choose managers who will outperform the market. This is actually where I violated a rule that I teach my students, which in hindsight, I’m really upset about. But I teach my students never project yourself onto your customer base. You’re not necessarily the customer. The same goes for when you’re evaluating an idea. I can’t tell you how many people say, “I wouldn’t use that. Therefore, it’s a bad idea.” That’s irrelevant. The only thing that matters is does the target customer want this.
So the thing that I validate is over the year and a half that we managed that marketplace of investment managers, post-selection, the managers on average outperform the S&P 500 by 4%. That’s ungodly. Now, I’m not going to represent that we’re going to continue at that rate, but let’s say we can continue to outperform by 1% a year and you gave us $50,000. You had $50,000 and you gave us 30% of that at $15,000. If I were to get you another 1%, I’m giving you another $150 a year.
Andrew: I see.
Andy: Is it worth it to you to split your money up into multiple locations for incremental $150?
Andrew: I see.
Andy: Probably not. But if you’ve got $500,000 or $5 million, it is. But that’s not the audience we were targeting. And of course, duh, it wasn’t convenient enough.
Andrew: I see. I see. It’s through those phone calls that you understood it and then where did you get to the point of–you used the word desperate that I wrote down in my notes. What was the point they were desperate for?
Andy: Well, I’ve reduced my entire product market fit class to one question. That is what do you uniquely offer that people desperately want because if they’re not desperate, there’s a good enough alternative. Let me tell you, if there’s a good enough alternative, you’re doomed.
Andy: So, if you want to build a big business, an advantaged business, people need to be desperate. So what I learned was that people who were delegators couldn’t afford the minimums associated with advisors, and they were desperate to have someone do it for them.
Andrew: I see. That’s what you were picking up on. You did it by hand. You went all automated. How did you know that all automation was the way to go and then why now are you guys transitioning to automating plus people for picking–
Andy: We’re not transitioning to automation.
Andrew: You’re not?
Andy: No. Quite the contrary. What we’re doing is we’re taking even higher end services that no one ever envisioned being able to be delivered through software. For example, on February 2nd, we launched financial planning. So financial planners are no different than travel agents. When they meet with you, they interview you for the inputs to a commercial software package that they all use.
Andrew: I see.
Andy: They go back into their office. They type in your inputs. They bring them back to you two weeks later and then show them to you. You edit them. You go back to your desk, input them again.
Andrew: I’ve literally seen this, by the way. I’ve seen financial planners do that.
Andy: Okay. Well, with APIs, I can now access all of your information and I have a much better idea of what you’re spending in your savings than you can guess right now. So number one, it’s a lot more convenient. You don’t need the interview. Number two, it’s immediate. You see the results immediately. It’s interactive. You can immediately play with them to change the assumptions.
Andrew: I see. It would be things like, “When do I plan to retire? Do I have a home or not?” that kind of thing.
Andy: “How long do you plan on living? Do you think your savings might decline because you’re putting your kids through college?” In future releases, we’ll show the interactions of your retirement savings with your college savings for your kids. Our target audience are under 40. They might be saving to buy a home. That’s not what a financial planner typically deals with for someone who has a minimum of $1 million. We think we can deliver a radically better solution through software just like Expedia and others probably do a hell of a lot better job than a travel agent.
Andrew: I’m trying to think of when someone goes to a financial planner, it’s often something like their company gives them some kind of investment product or a collection of options. They don’t know what to pick and they go there. Do you guys handle that?
Andy: Of course. That’s all in the software.
Andrew: So you go into the software. I go to Wealthfront.
Andy: They’ll tell you what’s ideal for your situation.
Andrew: I see. And it’s all automated.
Andy: All automated.
Andrew: No more people?
Andy: You don’t need people.
Andrew: When did you come to that realization?
Andy: As a matter of fact, what would you rather have working for you, three PhDs from Harvard, Stanford and Princeton designing what was ideal for you or a guy who graduated from Dubuque University doing your financial plan?
Andrew: I see. You’re saying your software was created by those guys, the best?
Andy: No. The investment products were conceived by finance PhDs. Our chief investment officer is Burt Malkiel, the man who invented the index fund, who wrote a famous book called “A Random Walk Down Wall Street.”
Andy: You’re getting the best of the best designing solutions for you personally.
Andrew: What are you doing about new companies now like Robin Hood, who are saying, “We’re not going to charge anything?” That’s not your market?
Andy: Well, Robin Hood is focused on the do-it-yourselfer. So they build a solution to allow you to trade stocks for free. We think that Robin Hood is a nice complement for people’s play money. So it’s really like dieting. If I asked you to eat nothing but salad and broccoli every day, you’re not going to keep up with that after a while. If we tell you, “Investing is boring. You shouldn’t try to outperform the market. You just buy index funds and you rebalance them and you minimize the taxes on them and so on.” Well, that’s boring. People want to play.
So what we tell them is, “Why not put aside 10% of your money into play money and you can see how you do with that, then put 90% of it into a long-term stable kind of plan like ours.” We think Robin Hood is a great way for you to play, or if you’re a do-it-yourselfer, it’s a very cost effective way of doing that.
Andrew: I asked someone on your team, I said, “I see you guys advertising everywhere.” She did the same thing you did right now. She squinted and said, “We don’t buy a bunch of ads.”
Andy: Our competitors do.
Andrew: Your competitors do. But I still know Wealthfront. It’s because of the PR and what else? How are you getting customers if you’re not buying ads?
Andy: Well, we started–so I’m a big believer, another thing I teach in my product market fit class is the importance of the technology adoption lifecycle that was promoted by Geoffrey Moore in a famous book called “Crossing the Chasm,” a book that every entrepreneur needs to read.
Andrew: And no one reads anymore.
Andy: No. It was “The Lean Startup” of the ’90s.
Andrew: Meaning all the innovators read that book and now all the innovators are going after the Lean Startup methodology and forgetting about that book.
Andy: Exactly. So the basic premise of the book is if you want to build a big business, you don’t go after the big market first, because those people only buy based on references, and you don’t have the references. You need to create a beachhead, a niche you can dominate. Through references, you grow from that niche of early adopters. Our early adopters were people who worked in tech companies in Silicon Valley. One of our investors actually had this great insight.
At our board meeting just prior to our launch, the current service, I said, “I’m really convinced that what we offer is compelling. The problem is people don’t know how to evaluate a financial advisor.” So they use the only proxy they know, which is assets under management, figuring that someone who has more assets under management must be better. Nothing could be further from the truth. That means they’re good salespeople, not that they’re good investors.
Andy: So one of our investors, a former partner of Kleiner Perkins, by the way, said, “Andy, I think you would be well served to focus here on people in Silicon Valley, young people in Silicon Valley because they’ll care more about the quality of the user experience than they will the assets under management, especially give your reputation, the reputation with the management team.
That was the best advice we’ve ever gotten. We started with young people in tech and we started with engineers in tech, and then they told the product managers and the biz dev people and the salespeople and then they told their friends who they went to college with and might be lawyers or doctors but not yet rich–there’s a term for it, HENRY, high earning not rich yet.
Andy: They told their friends about it locally and then they told their friends about it nationally and they just kept growing through word of mouth. We also did something that because we were initially focused on young people in tech, we decided to use an internet business model versus a financial services business model. The traditional financial services business model is you charge a high fee for small accounts and then you decrease the price as the account increases.
We did the opposite. We modeled after Dropbox. So just like back in the day, Dropbox gave you 2 Gb for free and 250 Mbs for everybody you invited and the invitee, we offered $10k managed for free and for everyone you invite, you and the invitee each get another $5k managed for free. If you invited five of your friends, you’re now up to $35,000 managed for free. This was an incredibly economic way to drive our usage.
Andrew: I had no idea. What percentage of your customers are coming through this invitation process?
Andy: A third.
Andrew: A third?
Andrew: Through the Dropbox methodology?
Andrew: And the least amount that someone could put in is $500.
Andrew: So if I want to try software, I can go and try it for free. If there’s like email marketing software that I don’t want to move away from mine. I want to try someone else, I can go try it for free. Same thing here, $500, I go try it completely for free?
Andy: Yes. Why is it that Wall Street doesn’t do this? Because they don’t like the little guy.
Andrew: They don’t like the little guy. I was even a little skeptical that there was value in the little guy, but I understand what you’re saying now. The little guy comes in and he grows with you, then also could potentially market to his boss to get more free–
Andy: Now you understand.
Andrew: I see. Then for someone who says to you, “Andy, you’re going after Silicon Valley. Silicon Valley is a small part of the world. Why are you staying this bubble?” You’re going to say, “I’m focused on this niche because. . .”
Andy: That’s where we started. That was a beachhead. It’s now 40% of our clientele. So we’re in all 50 states. Actually, when we did a query the other day of how many states are in it, the answer came back 53.
Andrew: How do you get another three?
Andy: Well, it turns out Washington, D.C. is considered a state.
Andy: Then there are two military regions. We have close to a thousand service members as clients because it’s set it and forget it. When they deployed, they don’t have to worry about it.
Andrew: I see. Why don’t we just close out with this last question–I asked someone on your time, “Is there something about color or something that gives me a sense of who he is? What’s his desk like?” You’re smiling. What is your desk like? You know the answer.
Andy: We look like every other consumer internet company, which means everyone has a desk that’s about–I’m looking at them now. They may be four feet by five feet. They’re all next to one another. It’s a big bullpen. I move around every two weeks.
Andrew: So you’ll be in one desk today, another desk the next, the next few weeks so you can get a sense of the whole company?
Andy: Yeah. It makes them feel value that care about their function and want to know what’s going on in their function as well. It keeps us really flat.
Andrew: I’ve got to tell you. People keep asking me about celebrities, like, “Want to have Richard Branson on?” or asked me about celebrities who I’ve had on. I’ve got to tell you, to me, yeah, I do it because it’s great to build up the audience excitement. But for me, having you on here is a bigger honor. The things that you have built, the fact that you would even go–I think that says so much that you went to Stanford and you taught a class on this. I love how you’re willing to talk about business, what you learned over the years.
If you gave me nothing but that I’d be excited, but not to also find out about Wealthfront, I’m really super excited to have on here. I’m going to hold it there because when I get excited, I don’t use my words properly. I’m just going to say thank you so much for doing this.
Andy: You’re super kind. Thank you, Andrew.
Andrew: All right. And the site for anyone who wants to go check it out, it’s Wealthfront.com.
Andy: Wealthfront.com. But for your listeners, we’ll make a special offer. How about this? If you go to Wealthfront.com/Mixergy, we’ll give your listeners an extra $5k managed for free. So you open the account, they’ll get $15k managed for free.
Andrew: All right. And then when they tell their friends, I get another $5k and another $5k and another $5k.
Andy: Their friends get it too.
Andrew: I’m going to go check it got because frankly as I was researching this I got very excited. I said, “Why don’t I do this?” Here’s the thing. I’m kind of a chicken. I like that I made my money. I don’t need to lose it at this point. I’ll take risks with work. I won’t take risks with what I’ve learned.
Andy: It’s a no risk portfolio.
Andrew: Right. I like that. And yeah, I like it. I’ve talked about that in the past, but I’m very low risk when it comes to my savings. I like that I get a little bit of place where I can tweak it. I’m not super low risk, but I’m not high risk either and I get to go in and tweak the system. Wealthfront.com/Mixergy if you want to check it out.
And of course my two sponsors–the company that will help you hire your next great developer, Toptal.com/Mixergy and the company that will help you design your next logo, website, anything at all, DesignCrowd.com/Mixergy. Andy, it’s an honor. Thank you.
Andy: My pleasure.
Andrew: Thank you. Thank you all for being a part of it. Bye, everyone.