Finding Genius

by Kunal Mehta

  In the next section, I’ll share theses from investors looking at how investment opportunities within specific industries will evolve and present themselves. In comparison, other investors are interested in the next platform shift, similar to the previous transformations incited by the Internet, software, and mobile. And others still, as they wait for this shift, are continuing to invest and search for opportunities around using data for more complex businesses in computational biology or applied robotics. Josh Nussbaum of Compound, for example, shares his take on this next generation of venture capital investing:

  “I’m excited about applying data to complex activities like computational biology, where we are now capturing health data, understanding what it all means, matching it to physiological data, and understanding certain diseases to develop drugs. This same frame of thinking can be applied to robotics and teaching them to process complex environments to eliminate the need for humans to do repetitive or mundane processes. I’ve been fascinated by the rise in voice interfaces. Airpod adoption may be the tip of the iceberg. With airpods, you can see ‘always-on voice computing’ becoming a reality as Siri uses data and behaviors to become more intelligent. Another area of interest is around decentralized apps on ethereum or blockchain. This idea of the world becoming decentralized is interesting especially with world events, such as Brexit and Donald Trump being elected, that show the divide in communities. These patterns are driving people into niche communities, where people have more in common in digital interest groups than they do in their own countries.”

  Investors like Nussbaum remain fundamental optimists that technology will continue to evolve, and entrepreneurs will find ways to build disruptive businesses on top of it. Yet, as entrepreneurship becomes more commonplace and more and more individuals attempt their own startups, an obvious question presents itself: is ‘genius’ being diluted as more ‘tourist entrepreneurs’ flood the ecosystem looking to make their own mark?

  Genius: Diluted

  ‘Genius,’ as defined earlier in this book, is a term reserved for a few outliers in society. With over $56 billion poured into venture capital funds in 2018, the discipline of funding only true ‘genius’ has wavered. VCs have not been as stringent as they once were in the past with who they fund. Similarly, more ‘entrepreneurs’ are joining the modern day gold rush and attempting to start companies that are merely solutions in search of problems or that lack true customer validation or value. As referenced earlier, these ‘tourist entrepreneurs’ may experience the lifestyle but rarely commit to the challenge of starting a company. Yet, they still get funded. As more founders join the ecosystem, how has the abundance of capital and entrepreneurial ideas diluted the ecosystem? Are we up against an overcrowded entrepreneurial market where geniuses are hard to spot? Beth Ferreira discusses this phenomenon:

  “The number of people who are starting companies each year is insane. These are all talented people, but you also want the most talented people working on the best ideas, not all starting companies. Founders need to be at the right place in their life and with an idea they’re passionate about that they’re ready to sacrifice everything else to do it and accomplish it. My concern is we celebrate all the wrong things and people are getting funded that shouldn’t be funded. We need to be more selective. I think there is a disconnect on what it means to take capital. You have to really believe who you’re about to build something really big. If you’re not in that place, you 100% should not take capital. Not everyone has that ability to build and throw it out there in the world. You have to find what your iteration tolerance/spectrum is.”

  The ‘Zuckerberg effect’ — chasing entrepreneurial dreams in hopes of becoming billionaires — has led to flocks of new founders entering the ecosystem. Separately, employees are leaving established companies (like Fab, mentioned above) to launch their own businesses. While the market will stabilize and weed out the ventures that shouldn’t exist, Matthew Hartman of Betaworks recognizes that investors need to be more discerning during this upswing in venture capital. He says:

  “I bet Mark Zuckerberg’s story pulls people out that would have otherwise been in private equity or investment banking, who were chasing wealth. Yes, I can see the entrepreneurial pool being diluted in 2019. As investors we need to be better about deciphering between the noise and the real. Are you starting a company for its own sake? An idea that you can’t shake? If not, you’re probably chasing the wrong things and an investor needs to discern if you’ll quit at the first challenge.”

  Entrepreneurship and startups have become pervasive in our culture and with it, there are more people starting companies without the required experience or insights. At a high level, investors like Ellie Wheeler believe it is a good thing that entrepreneurship has become more accessible, but are weary of ‘tourist entrepreneurs.’ She explains:

  “There are those people who are tourists — this is a hot space, I can go do something big — typically they use a lot of lingo, they just don’t have that ‘genius’ factor, and they’re coming at it because it’s a shiny new object. Those people do not have staying power. Yes, there has been an influx into the tech ecosystem and overall that’s a good thing, but we also need to be conscious that there are now going to be more people chasing that dream but they don’t have what it takes. It is an unfortunate byproduct of the tech media being only about fundraising announcements. It’s a necessary evil on a path to something else, but celebrating fundraising announcements is not a valuable use of time, at all. It’s changing the definition of success.”

  Wheeler however, agrees with Beth Ferreira that VCs will need to be more disciplined through this next generation of investing. As more funds enter the ecosystem, venture capitalists will need to be disciplined with the metrics they follow but still seek out higher returns to justify the massive funds that they have raised. As discussed earlier, the definition of success can be far different for a founder and a venture capitalist because not all businesses should be venture-backed. There are countless examples of founders who never raised outside capital and they owned 100% of their business. In that instance, a $10 million sale of a company is $10 million directly to the founder. If the same founder raised $5 million in capital, a $10 million outcome is not as exciting for the founder or the investors.

  As investors take their stakes in companies and search for higher valuation multiples, there is a prevailing ‘greater fool theory.’ Investors will often overstate the success of companies within their portfolio to find an investor who can now fund the next round of a company, which may or may not even deserve a higher valuation. The greater fool theory is prevalent in a venture ecosystem that is focused on growth, at all costs. This leads to founders raising and spending more capital without a sound business model. These businesses often have negative unit economics or are venture subsidized the entire time. As entrepreneurs and investors, it is important to have a disciplined perspective on the fundamental economics when evaluating a business opportunity. Jonathan Teo, a former partner with General Catalyst, discusses the greater fool theory and how as an investor, he remains disciplined on staying away from the frothiness of high valuations and public fundraising announcements. Teo says:

  “We always make this comment internally that we don’t invest with the ‘greater fool theory’ in mind. We look at companies that have a strong potential to be public, independent companies with solid business models in place. If you look at many consumer packaged goods companies out there today, they’re not being built on strong fundamentals but instead have business models that are venture subsidized. These businesses won’t scale well because over time, as they stop finding customers organically, they’ll spend more venture dollars to acquire more customers. As a result, their margins will be compressed, eventually driving their prices up. Eventually, this all leads to a serious attrition of customers. There are a lot of issues at play in these businesses but because they are in this growth mode where they are building a brand, some investor may jum
p on board. Companies like these are fueling the ‘greater fool theory’ and you may get a less sophisticated who wants to jump on that kind of growth. These types of exits and outcomes are never good for anyone — the founder or the VCs.”

  As Teo suggests, the main result of an influx in capital into a ‘hot’ company is the excess spending of that same capital. What happens when there is too much money? Entrepreneurs find a way to spend it — often not efficiently — and you’re left with a situation of startups outspending each other in order to try to acquire as many customers as possible. In 2019, consumers are likely familiar with businesses that offer $50 for the first at-home meal kit or $10 to use the new food delivery service. While consumers love these initial benefits, if they do not continue to use the service, the business loses that money they spent to acquire them in the first place.

  Teo, like other investors, believes that in some cases, for a short period of time, this model may work to spur growth; but it is important to look for deals not based on public perception or false success metrics. At the time of our conversation, Teo was searching for deals that were not getting done because that specific industry was unpopular. With other investors, he was staying away from ‘hot’ companies that were raising money only on a growth story, but lacked a solid business model. Capital that feeds growth is typically not just feeding an unsustainable model but also breeding really bad behavior from an entrepreneur. It’s facilitating the need for them to spend on marketing and branding instead of answering the tough questions to get intimate with their value proposition and figure out the real problem they’re trying to solve. Teo believes in the future, the market will stabilize and weed out these companies. He says:

  “I think this bad behavior will get slowly filtered out. Prices are an assumption of demand. There has been more demand for private equity because products are not making their way to the public markets. Some of the exits you see in the space are purely around the greater fool theory and no one is regulating this. You have entrepreneurs and investors feeding this frenzy for a land grab, but it is not sustainable. We should start seeing far less capital come into companies at insane valuations, because it becomes clear that you may not be able to get downstream financing at a high price. Unsophisticated investors all make the same mistake. They’re not looking into the underlying business to understand what drives their sustainable advantage. You see a lot of investors trying to jump on the coattails of growth, and growth has been all of what Silicon Valley investors have spoken about over the past few years; but growth should be fueled through discipline and core business values. I think the future looks great for technology and entrepreneurship, but we need to return to basics.”

  Beth Ferreira sees this pendulum starting to swing back to this direction. In the first quarter of 2019, she saw investors demanding more proof points. Whereas 18 months prior, Ferreira reflects, it was easy to raise capital only on a pitch deck. She explains:

  “The pendulum has swung, and most logical investors want to see a proof of concept, revenues or a working product. When you look at some of the companies that have traditionally been started out of business schools, they took the time to build a proof point. Warby Parker didn’t raise capital at first, they just tested out their theory and when they had the proof of concept, then they started thinking about that. I think there is a disconnect on what it means to take capital. That’s why we like to back engineers because they are system thinkers. There are a couple of groups of people I’m advising who see problems and they try to build a product as their first instinct. They build one that doesn’t work and keep testing it and finally stumble on something that works.

  A decade from now, venture capital will look entirely different than it does today. The industry will continue to go through dramatic shifts in order to better serve entrepreneurs. In 2019, Matthew Hartman of Betaworks was in the process of launching Betaworks Fund II on the back of the success of the first fund. As he looks at the landscape around him, he recognizes the volatility surrounding venture capital: AngelList’s impact, the noise of ICOs, venture capital funds growing larger in size, pre-seed funds emerging with access to new capital flows, governments and corporations all entering the ecosystem. Hartman recognizes that Betaworks too must evolve in order to stay relevant and his solution to this noise is to focus:

  “With everything that is going on around us, how do you do early investing at a scale where you’re adding a lot of value? As the competition for breakout deals increases, we need to be focused. Our solution is to focus on areas of interest and find the best companies in that space before anyone else does. For example, we launched Voicecamp and Botcamp. In Botcamp, we accepted eight companies into our office that were exclusively building technology around chatbots. We invited the big players, like Slack and Facebook, that could leverage this technology. We helped them think about product, market, launch strategy and by inviting enterprises, we could actually help them. At the same time, our team is also building companies so that we collectively learn a ton with the founders. We raise money for those companies that we’re building so we get a sense of the funding market for those companies. At the end of Botcamp, we end up knowing as much as anybody about that ecosystem. We can share that information with our companies, and we can learn to make better investments.”

  Across the board, venture capitalists seem to agree that funds — especially new ones — will be forced to have a point of view on why they are differentiated. Beth Ferreira, Matthew Hartman, Rebecca Kaden, and Keith Rabois all touched on this. Some of them do this through the people they hire, some through their industry focus, and some through their expansive theses. The proliferation of ways to finance a company will no doubt force venture capitalists to differentiate their offering. And if the trend of more sources of capital persists, there will be plenty of cases where ‘genius’ entrepreneurs will no longer need to touch venture capital money, because there will be an abundance of other sources of capital available to them.

  CHAPTER 10

  LOOKING FORWARD AND CONCLUSION

  “In order to be in venture, you have to be a persistent optimist and believe in the inevitable march forward in technology. You have to assume that everything is always going to get better. To assume it won’t is limiting, close-minded, and self-defeating.”

  Andrew Parker, Spark Capital

  In Search of Greatness, a documentary released in 2018, examines patterns of athletic genius exhibited by Wayne Gretzky, Jerry Rice, Serena Williams, Pelé, and Tiger Woods. It begins with an account of the “Combines,” where aspiring professional athletes compete fiercely across a series of physical tests such as the 40-yard dash or total weight bench-pressed. While designed to quantify athletic ability for scouts to base their recruiting efforts on, these tests rarely indicate future success. Tom Brady, the winningest NFL quarterback, demonstrated little potential based on the Combine tests in 2000. For the 40-yard dash, Brady was clocked at 5 minutes and 28 seconds — the slowest recorded time for any quarterback at the Combine as of 2019. Today, Tom Brady is undeniably an athletic genius. Scouts for the NFL had harsh criticism for this future star, as revealed by Brady in a social media post:

  “Poor build, Skinny, Lacks great physical stature and strength, Lacks mobility and ability to avoid the rush, Lacks a really strong arm, Can’t drive the ball downfield, Does not throw a really tight spiral, System-type player who can get exposed if forced to ad lib, Gets knocked down easily.”

  The same goes for hockey legend, Wayne Gretzky. In public interviews, Wayne Gretzky often speculates that he ‘would have been ranked the lowest’ in many measurements people now see as important. In Search of Greatness argues that athletes may have some biological or physical disposition that sets them apart, but it is the other, unquantifiable factors that allow them to achieve greatness. In that vein, Gretzky alludes to his obsession and creativity with the sport of ice hockey that allowed him to break all scoring records for the NHL. It was Serena Williams’ and Mi
chael Jordan’s insecurities about being second best, the documentary indicates, that sparked an intense competitive nature, and made the sports of tennis and basketball synonymous with their names.

  In writing Finding Genius, and through the series of conversations I have had with entrepreneurs and venture capitalists, I have come to understand that entrepreneurial genius cannot be measured or quantified through aptitude tests. It is not something a person is born with. It is not, as popular culture stories would suggest, a spark of genius that appears overnight. Instead, genius manifests itself by learning through unstructured environments, a sense of creativity, and having an unmatched tolerance for risk and failure. Genius is the result of an obsession with a problem and having the competitive drive to find the best solution to that problem. Venture capitalists have proven, through the success of the companies they have backed, that entrepreneurial genius can be found, nurtured, and supported. The open debate remains whether this search for genius is happening efficiently and equitably.

  Unstructured Creativity & Learning

  Ilya Fushman believes that geniuses emerge from unstructured and uncertain environments. After earning a Ph.D. from Stanford University and a failed startup attempt, Fushman worked for venture capitalist industry titan Pierre Lamond at Khosla Ventures. It was his role as head of business development at Dropbox, however, that earned him his reputation in Silicon Valley: he joined Dropbox when the company was only 50 employees and helped scale the organization to profitability. He then brought that operating experience gained at Dropbox back to venture capital, first as an investor at Index Ventures and as of 2019, as a GP with Kleiner Perkins. Over his venture career, Fushman has backed companies such as Slack, KeepTruckin, UiPath, and Robinhood. All of these companies, as of writing this book, are valued at over a billion dollars and each one is being led by founders lauded as ‘geniuses’ by those in Silicon Valley and beyond. According to Fushman, there’s one characteristic that sets the founders of these companies apart: they are all immigrants.