I recently updated my resource section to include a variety of papers and presentations I authored or co-authored while at Columbia Business School. As I was sorting through my hard drive and getting rid of old files, I realized that a lot of time and effort went into some of these and that someone, somewhere might find some of this information useful.
So I’ve uploaded some of these thought pieces under 3 different sections:
- Investment Memos: This sections contains three different investment memos on Airbnb, Prosper and Starwood. The first two are focused on later stage venture / growth equity investments whereas the Starwood memo is more of a traditional Buy/Sell/Hold analyst report.
- Roadmaps & Theses: The next three sections contain a set of VC style investment roadmaps from the two internships I did in venture. The first deck is a roadmap focused on wearable tech, specifically Google Glass, from my time at Gotham. The second deck is a playbook on vertical saas opportunities that I put together for BVP. The final paper is an initial viewpoint on the manufacturing software sector that I put together for BVP while doing a deep dive into the space.
- White Paper & Thought Pieces: The final section is more or less a catchall for a few other pieces that I thought were interesting but didn’t naturally fit into the other two categories. This section contains an in-depth analysis on M&A activity in the tech sector and the resulting implications for venture investors. This section also includes a deck that very accurately projected iPhone sales for Apple in Q3 of 2014 before actual figures were announced. Both of these papers rely extensively on regression analysis and other statistical methods.
So there it is, a few resources that I thought were interesting. I’ll continue to add to this collection as the opportunity arises.
Yesterday I graduated from Columbia Business School ending a two decade educational journey that started on the west coast and end here on the east coast. These past two years have been two of the best years I’ve had both personally and professionally. And so I just want to take a moment to say thank you.
My experience at CBS has been inextricably tied to New York City. Some of the best professional opportunities I’ve had were a result of being here in the city. During my first year, the guys at Gotham Ventures were nice enough to give me the opportunity to learn the ropes and get an insider’s perspective on the venture business. That experience was only enhanced during my second year when I worked on a variety of projects with Bessemer Venture Partners. Lucas and Brian – thank you both for taking a chance on me.
Back on campus, there were two organizations that really shaped my MBA experience. The first, InSITE Fellows, is one of the most innovative student groups I’ve come across. Before I even stepped foot on campus, I knew I had to join. Huge thanks to the year above me for letting me in and the current fellows for being the smartest yet also most humble group of soon-to-be founders, investors and technologists I know. And a big thank you to the folks at 2U, Betterment and the many other startups I was fortunate enough to work with.
The second group was my cluster—Cluster E. I really couldn’t have asked for a better group of people to spend time outside of class and work with. Within my cluster we had a diverse mix of veterans, attorneys, teachers, entrepreneurs and of course…bankers and consultants. I’m amazed by how talented, but at the same time, down to earth everyone was. It was an honor to get to know all of you and I know this is just the beginning of many long friendships.
Finally, I have to thank my family, with-out them I wouldn’t be here today with this degree in hand. Mom, Dad and Andrew thank you for your support throughout these two years and throughout my entire life. Mom you have been my rock since birth—I’d be nowhere without you. Liza you have been my biggest cheerleader since our Cornell days; I can’t thank you enough. And to my extended family—I couldn’t have asked for a better group to celebrate the weekend with. I only hope that I can shower you all with as much love and support as you have showered me with.
And lastly, thank you Columbia Business School. What an amazing place #attheverycenter. Next stop, McKinsey & Company but not before one last stretch of traveling and relaxing with friends and family.
I have a lot of respect for Airbnb as a business and the tremendous growth of the company in just 7 years. Airbnb currently boasts 1M+ listings across 34,000 cities and 190 countries. Though still a private company, revenue estimates for 2014 were said to be over $400M w/ yoy growth of 65%. Not bad for a company many famously passed on (including Fred Wilson) or wrote off as completely absurd. I’m confident the founders and early investors will be handsomely rewarded when the company eventually goes public.
I do, however, have concerns with the current massive round that Airbnb is raising. And it’s a concern I believe should be shared by many of today’s unicorns and, in particular, their later stage investors. If I were a prospective later stage investor in Airbnb’s $1B round, I would not invest at this stage and at that valuation. My thoughts can be summed up in three points:
- A $20B valuation overinflates the true value of the business, which by my analysis is closer to ~$10.2B. This high private valuation will hinder returns for later stage investors—it’s a problem I think many of today’s later stage investors in unicorns are going to face. The infographic in this Forbes article shows a similar story with one of the more recent unicorns to go public: Box.
- Airbnb has important competitive advantages in terms of network effects and customer captivity—they may even have a bit of a regulatory advantage thanks to their scale. The problem is that Airbnb has nothing that will allow it to be a complete “winner-takes-all” business. At the very least, it will have to share TAM with its most direct competitor, HomeAway, not to mention all the major hotel chains that have been around for decades.
- There are a number of unknowns that make Airbnb a risky business to invest in including: macro-economic tourism and vacation trends, the decentralized nature of regulation and an uncertain cost structure that is likely to erode margins. Some of these unknowns could be very detrimental to Airbnb’s growth and continued success as a business.
For a more in-depth analysis of the investment opportunity, I’ve put together an investment recommendation deck below:
The history and evolution of the travel and transportation industry is really quite fascinating. How we arrived at today’s mix of companies (both the incumbents and insurgents) is a story of technological innovation, savvy business positioning and a macro trend around increased travel and connectivity.
In today’s world, the range of different companies is quite impressive. On one end of the spectrum, you have the traditional, asset-heavy giants. In airlines there is United, Delta, American Airlines and many more. In hotels, Starwood, Hilton, Hyatt, and others dominate the scene. And in car rentals, Hertz, Avis, Enterprise and others have long been staples of ground transportation. Seeing the challenges that lie ahead, many of these travel/transportation behemoths are moving towards an asset-light approach and beefing up their digital and mobile offerings. Starwood for example has sold off nearly 85% of its properties in the last decade. They are moving more towards an approach that relies increasingly on a franchise / management fee model. Similarly Starwood has also invested heavily in their mobile app, which has paid off. In recent years, mobile bookings have increased 300% yoy and mobile revenue is a growing portion of total revenue.
In addition to the traditional players, you also have the .com darlings of the late 90s and early 2000s. These companies are particularly well represented among the OTAs. Oribitz and Expedia for example rose to prominence by helping consumers find and compare various booking options across the various legs of their vacation journey. Many of these companies have gone on to do quite well—though increasing competition has threatened earnings and growth. In addition to the OTAs, travel discount sites (such as Priceline) and review sites (such as Trip Advisor) were also largely born during this era and continue to do quite well.
Finally, there are the emerging companies of today that have successfully taken advantage of increased mobile connectivity, macro trends around the shared economy and advances is geo-location technology. In the taxi cab world, Uber, Lyft and others have built unicorn valuations in eye-popping speed. In vacation rentals, HomeAway and Airbnb are leading the charge to provide sellers with liquidity and renters with cost-effective options in those two-sided markets. And in mapping, Google Maps and Waze (acquired by Google), have greatly enhanced mapping capability. Not to mention the rise of ride sharing companies (Via, Sidecar, etc.) and parking services (Luxe, Zirx, etc.) which are just getting started. In the coming years, vertical cloud saas companies will only further enhance the options that consumers have today.
All in all, it’s a really interesting time to be in travel and transportation. I’ve put together a map of the travel and transportation ecosystem below. It’s certainly not all-comprehensive by any means, but it provides a general overview of these various players and trends. Hopefully it’s a useful guide to navigating the various sub-categories and players in the industry.
Over the course of the last century government has always found a way to influence the course of business through regulation. Traditionally, however, the government has tended to focus regulatory efforts on large enterprises. The vast majority of startups often fly under the radar as they are too small to really create concerns for regulators. The select few that do balloon into bigger companies through super-sonic growth, i.e. the Ubers and AirBnBs of the world, often do encounter regulatory hurdles as they grow into large enterprises. The reality, however, is that government regulation, in certain industries, can be game changing even at the earliest of stages. We need look no further than peer-to-peer (P2P) lending as an example.
Going back a decade to the mid-2000s, P2P lending was a nascent industry that had begun to shape into a two-horse race between Prosper (founded in 2005) and Lending Club (founded a year later in 2006). At the time, U.S. consumers had about $880 billion in credit outstanding and the virtual marketplaces for P2P lending were thought to reach $300 billion in loan origination per year by 2025. It was (and still is) a huge and growing market with lots of potential. As the first mover in the space, Prosper had jumped out in front by the end of 2007, facilitating 10x the number of loan originations as Lending Club. But 7 years later, Lending Club went on to IPO in December of 2014 and now has an enterprise value of $9.6B. Prosper has fallen to a distant 2nd and has struggled to find demand for an IPO—withdrawing its filing process on numerous occasions. So what happened?
The answer is government regulation, which provided Lending Club with a huge competitive advantage over Prosper in the early days of P2P lending. The critical issue that came up in 2008-2009 was over whether the SEC would view the loan transactions Prosper and Lending Club were facilitating as promissory notes, without any filing requirements, or securities, which (at the time) had extensive and very expensive filing requirements.
Prosper took a more passive “wait and see” approach to this regulatory issue—hoping that regulators would simply view the underlying assets as promissory notes and leave them alone. Lending Club, however, had the foresight early on to see the danger with this approach. If the industry was forced to file with the SEC, everyone would have to shut down for 6 months and submit to the long and expensive registration process. As such, Lending Club chose to take a proactive approach in being the first movers to file. Moreover, they actually helped the SEC shape much of the regulation in P2P lending which provided them with a huge short-term advantage over the competition.
As soon as Lending Club finished their filing process, the SEC then ruled that every other P2P lending marketplace would have to do the same. This meant that they came out of the process right when everyone else had to temporarily shut down for 6-9 months. So for ~9 months (time it took Prosper to emerge from the process) they were effectively the only player in P2P lending, right as the market took off courtesy of the tailwinds provided by the financial crisis.
Many of the other early players essentially shut down due to the heavy costs of filing and the lost time. Prosper managed to hobble out of the process but by then the damage had been done. With 9 months of green field, Lending Club had built out both sides of the two-sided marketplace, enhanced their network effects and customer captivity and emerged as the #1 player in P2P lending. The last 5 years Prosper has been playing catch-up as best it can. So government regulation was game-changing early on in P2P lending.
However, the story doesn’t really end there. While Prosper and Lending Club continue to do pretty well, the challenge for both of them is that they don’t have much by way of long term competitive advantages. The image below shows their respective competitive advantages at 2 different points in time.
We’ve already discussed the early days of P2P lending, so let’s shift our focus on what is happening now in 4 cores areas: (1) government regulation, (2) scale, (3) customer captivity and (4) cost.
- Government Regulation: Having cleared the SEC regulatory filing process, Prosper emerged wounded but alive. The problem with regulation now, however, is that in many ways Propser and Lending Club cleared the way for everyone else. The SEC filing process is now much faster and less costly. So there no longer exists a true competitive advantage for either from a regulatory perspective.
- Economies of Scale: Neither Prosper nor Lending Club ever had an advantage in terms of fixed costs. These are software marketplace business that are not capital intensive; that basic principle remains true today. What has changed is the strength of the network effects.
- Since dropping the auction-style borrower/lender matching process and migrating to the Lending Club method of assessing credit risk (through FICO scores and other metrics), the number of credit-worthy borrowers and therefore lenders willing to lend has increased tremendously on Prosper’s platform. The result has been a strengthening of Prosper’s network effects. They have now done $2B in total loan origination, which is a third of the $6B Lending Club had done.
- The challenge though for both Lending Club and Prosper, however, is that the networks effects are not unique to their platforms. Lenders are simply in search of credit-worthy individuals in this low interest rate environment. As lenders on these platforms continue to move away from individuals and towards institutions, they will be increasingly more willing to multi-home across multiple platforms in search of the most credit-worthy borrowers and the highest yields. Borrowers will also multi-home in an effort to find the lowest interest rates as well as the most personalized / specific marketplace—hence the rise of P2P lending in specific verticals (more on this below).
- Customer Captivity: Admittedly, I don’t have much by way of evidence but my belief is that as network effects begin to dwindle on both Prosper and Lending Club, so too will customer captivity. This will be most notable in terms of customer acquisition costs. Around 2010/2011 it cost Lending Club ~$40-$60 to acquire each borrower and ~$20 to acquire each lender. I am positive that this is higher than CAC in 2009-2010 when Lending Club barreled its way out of the SEC filing process as the only player and lower than what they will have to spend in years to come to acquire customers. Expect to see marketing and sales spends as a % of revenue to increase as well as higher churn and a lowered ARPU/CAC ratio.
- (Supply) Cost: Early on, Lending Club and Prosper may have had a slight supply advantage in terms of proprietary knowledge and/or special resources. Their algorithms matching borrowers and lenders as well as probability of default may have provided them with a slight edge—particularly given the larger amounts of data they had as a result of being in business longer than others. Unfortunately, this too is not a sustainable competitive advantage. The technology in P2P lending over time has become increasingly commoditized—there are only so many ways you can assess credit-worthiness and, given enough brain-power and time, the technology can be easily replicated.
So the overall affect for both Prosper and Lending Club has been a weakening of their competitive advantages vis a vis the rest of the P2P lending market. This has resulted in a whole slew of new entrants fighting for share and cutting into the once high (as high as 40% for Lending Club) margins. Here’s a look at how the competitive landscape is shaping up today:
In particular, the last few years have given rise to vertically focused P2P lending marketplaces. These vertical P2P lending marketplaces focus on specific verticals like student lending (SoFi, CommonBond, etc.) or SMB lending (OnDeck, CAN Capital, etc.) Because they offer a specific focus or thematic lending opportunity, the network effects and customer captivity of these offerings tends to be high. While still mostly small and narrowly-focused, these vertical P2P lenders have broadened the P2P lending marketplace into more than just a 2-horse race.
Cap tables are an important concept for entrepreneurs to grasp when taking outside financing. A cap table is a schedule that lays out the ownership stakes in an early stage company. They typically take the form of a spreadsheet that changes over time as more capital is raised and more investors become involved in the growth of a company. Cap tables can also vary based on whether the capital is raised through equity or through convertible debt (debt that converts to equity at a future point in time).
Much has been written on the merits and challenges of both equity and convertible debt. There are a number of great posts that explain each at a high level and then go on to take a stance on which method is preferred and when. A number of notable investors have weighed in on the topic through a variety of posts including: Fred Wilson, Mark Suster and Josh Kopelman. All of these posts do a great job of explaining the mechanics of each financing option and provide sound reasoning around when (and when not) to use convertible debt vs. equity.
The problem with these sources, is that rarely do they actually dive into the mechanics of building a cap table from scratch and modeling out the differences over time of equity vs. convertible debt. Of course, there are courses taught by organizations such as Wall Street Prep that do extensive training around cap table modeling. While these courses are great, they tend to be a) very expensive b) time-consuming and c) highly detailed-oriented (too detailed for what most entrepreneurs are looking for). So what do you do if you’re an entrepreneur who wants more than just a high level understanding of the pros and cons of various financing options but doesn’t want to pay a premium for a time-consuming, detail-heavy course?
I recently came across a great resource put together by my Professor at CBS and 37 Angels founder, Angela Lee. Professor Lee has built a step-by-step guide to modeling out cap tables for equity and convertible debt deals (both when the discount or cap come into play). The guide, which is posted below, provides detailed instructions on how to calculate the various components of a cap table (shares owned, share price, % owned, etc.,) across various rounds of fundraising. Although the tool is simplified, it provides an intuitive way to model various financing scenarios and their implications for your ownership over time. Hopefully this sheds a bit more light on the mechanics of how cap tables are put together. Big thanks again to Professor Lee!
A few days ago, Dan Primack and Erin Griffith from Fortune put out an article entitled “The Age of the Unicorn” along with a nice list of the 80+ unicorns currently in business. In addition to providing a working definition of the “unicorn” (essentially a pre-IPO tech startup that has reached a $1B market value), Primack and Griffith go on to describe some of the characteristics of today’s post-bubble unicorns and why these companies have become much more commonplace. I decided to spend a little time looking at their list and gathering a little bit more information on these companies.
The first trait worth noting about today’s unicorns has to do with their actual valuations. While the mean valuation of these companies is nearly ~4B, this average is heavily affected by a few of the upper outliers—companies like Xiaomi ($46B), Uber ($41B) and Palantir ($15B). There are only 8 “decacorns” (companies with a $10B+ valuation); the majority of these companies fall in the $1-2B range. In other works, the collection has a long tail of companies that are “just barely” above the unicorn threshold. Importantly, these valuations are all on paper. For the founders and investors involved, these numbers are largely irrelevant until there is an exit to provide liquidity to these valuations (more on this towards the end of the post.)
Another characteristic worth noting is when these companies were founded. The average company life of these unicorns is 8 years—not all that surprising until you consider the fact that many of these companies have been unicorns for several years before Fortune published this list. In fact, the speed with which some of these companies have reached unicorn status is unparalleled. 7 of the companies (~9%) were founded in the last 2 years and 31 (~40%) were founded in the 6 years since the financial crisis. A mere 12 unicorns (15%), are dot-com survivors (founded in 2001 or earlier).
A final characteristic of the unicorn list worth noting is where they were founded. The chart below shows a story that is not all surprising—namely that the Bay Area is still King when it comes to producing fast-growing tech startups. That being said, the Bay Area’s “share” of unicorns, at 44%, is certainly not what it used to be. China is clearly a major force in the production of unicorns as is NYC and Europe. The surprise from a geographic perspective appears to be Southern California in 4th place—bolstered by the likes of SnapChat, SpaceX and JustFab. While not shown in the chart below, Boston and India are both tied for a close 6th with 3 unicorns each. Interestingly, each of India’s 3 unicorns are in the online retail/commerce space: FlibKart, SnapDeal and InstaCart.
There has been much debate on the drivers behind the growth in the number of unicorns, the macroeconomic implications of more privately held $1B+ companies and the possibility of a growing bubble. Griffith and Primack’s article provides a great overview of these debates and other related issues. One implication that is pretty evident, however, is that the IPO markets need to continue to stay strong in the next few years or venture investors are going to face disappointment. A quick example will help illustrate this point.
Let’s say you’re a VC who recently invested $100M into the latest round of a fast growing startup at a $900M pre thus providing the company with unicorn status based on its $1B post. As a VC, you’re looking for at least a 3x cash-on-cash return on this investment. In order for you to realize that type of return, the company you invested in needs to exit for at least $3B. Very few companies in the F500 can afford an acquisition of that size. Thus, in order to realize that kind of return, you will push the company (and its management team) to go for the IPO. This push for an IPO may be aligned with the founder’s goals but it may also come despite the attractiveness of an acquisition from the founder’s perspective. Even if there is full alignment on exit strategy, the whole thing will unravel if the IPO markets cool and there is no demand for these assets. Thus, the Age of the Unicorn is strongly tied to the strength of the IPO market. In the coming months, I think we’re going to hear a lot more speculation from the venture community on this very topic.