From Legendary Investor to Entrepreneur with Andy Rachleff: An EOFire Classic from 2021

0:01Boom! Shake the room, Fire Nation. JLD here and welcome to Entrepreneurs on Fire. Brought to you by the HubSpot.

0:30and teaches technology entrepreneurship at Stanford GSB. Previously, Andy co-founded and was general partner of Benchmark Capital. And today, Foundation will talk about how you don't find the idea. They find you from your authenticity and the opportunity because you will recognize the inflection points well before somebody else might. And don't focus on the percentage of times you're right. Focus on the magnitude of when you are and so much more. And a big thank you for sponsoring Today's episode goes to Andy and our sponsors. Success Story, hosted by my friend, Scott D. Clary, is brought to you by the HubSpot Podcast Network, the audio destination for business professionals.

1:06Success Story features Q &A sessions with successful business leaders, keynote presentations, and conversation on sales, marketing, business, startups, and entrepreneurship. In a recent episode, Scott brings Kate Bradley on the show, founder and CEO of Lately.ai, to discuss the best ways to use AI to create content. Listen to Success Story wherever you get your podcasts. Andy, say what's up to Fire Nation and share something that you believe about becoming successful that most people disagree with. I think you learn more from success than you do from failure professionally. I think you learn more from failure personally.

1:44Fire Nation, I've told you all about Andy in the introduction. I've teased the bullet points we're going to be talking about today. how Andy went from a legendary investor to an entrepreneur. So I want to talk about Benchmark Capital and Wealthfront to Start because, Andy, they are two very, very different businesses. So what inspired you, first and foremost, to create Benchmark and then eventually become an entrepreneur yourself? Well, I was one of five people who co-founded Benchmark, so it wasn't I who did it. It was a group of us. the inspiration for doing it was my previous venture capital firm which was one of the top five firms called Merrill Pickard Anderson and Iyer was going through a generational transition two of the partners were retiring which left the remaining three of us to decide did we want to take the franchise forward or did we want to become free agents and do something different.

2:39At the same time, another one of the top five venture capital firms was going through this same sort of generational transition where the founding partner wanted to retire. And that firm's name was TVI. My partner, Bob Cagle came from TVI. Bruce Dunleavy and I came from Merrill Pickard. Kevin Harvey was an entrepreneur that we had backed at Merrill Pickard. And so So what united the four of us, there was a fifth person, but he didn't last very long. But what united the four of us was a desire to build the best firm in the business. We didn't believe that we could do that with our previous franchises, even though both were probably in the top five in the business.

3:26We thought we needed to do something radically different in order to rise to the top. And so given that each of Merrill Pickard and TVI had decided not to raise a new fund and just to wind down their operations, that allowed us to become free agents to start something new. So Fire Nation, the evolution of people that are going into the world of entrepreneurship is always a fascinating one because there's a lot of decisions that go in to that process. And that's what I would love to kind of talk about next, Andy, because Fire Nation is mostly made up of entrepreneurs, small business owners, and the world of venture capitalists are kind of foreign to most of us.

4:11So let's just kind of break down what we, Fire Nation, entrepreneurs in general, can learn from venture capitalists. But I also would love to flip it around as well and have you share with us what you think venture capitalists can actually learn from entrepreneurs. Well, the biggest thing that venture capitalists enable is companies that require capital to succeed. most companies that gain their advantage from intellectual property require the capital to build that intellectual property they can't bootstrap themselves into the development of it into the development of the software so they need outside capital in order to pay for the engineers that they need to attract and the only people who have the capital and the appetite for the risk are the venture capitalists.

5:03So it is a necessary requirement if you want to try to build something large. If you want to build something small that you bootstrap and you sell for 10 or 20 million dollars, you absolutely don't need venture capital. If you want to try to build a business that has a chance to build, to generate 50, 100, a billion dollars of revenue, in that case, you need venture capital. And what differentiates the venture capitalists really is, number one, their network, number two, their ability to help you with recruiting. But most importantly, and this is probably the least valued capability going into the relationship, but the most valued capability at the end of the relationship, if the company succeeds, is perspective on issues the entrepreneur is going to face once in his or her life.

5:57But the venture capitalist has seen a hundred times, not because they're so good, but because they've been around a lot of successful companies and they can share what other companies have done, not tell the entrepreneur what to do, but share the context so the entrepreneur can make a better decision. And I've seen that actually make an enormous impact on businesses. And on the flip side, what have you seen venture capitalists learn from entrepreneurs? The skill sets for the two professions are completely different. I remember for the last 15 years, I've been teaching a variety of technology entrepreneurship courses at Stanford Graduate School of Business.

6:36And one of the courses I co-teach with a very successful entrepreneur named Mark Leslie, who founded and ran a company called Veritas Software that he built into our billion-dollar revenue software business. and he was never fond of venture capitalists and was so excited when I started an operating company and he said boy you're going to be he said you would be such a better venture capitalists now as a result of having started the company and I said Mark I couldn't agree with you less because none of the skills that one develops to become a good leader or to run a company are relevant to venture capital.

7:15It makes you a better board member because I think you're more empathetic to the trials and tribulations of the entrepreneur. But in terms of deciding which company to pursue and which investments to make, nothing about entrepreneurship helps with that. So let's talk about product market fits, because that's one thing that I know as a venture capitalists, you've had to sit down and identify, does this product, does this service, does this vision that this entrepreneur have at least have a chance for product market fit? So break it down for Fire Nation, who maybe is in that stage right now. What is product market fit?

7:57And how do you know when you have it? Well, it's actually a term that I coined. So I'm the person who created that concept or the term, not the concept. And I've been teaching a course on it for the last 13 years. So I've really made a study of it. And my view is that at least in among technology companies, if you find product market fit, you can screw up almost everything you do and still succeed. Conversely, if you don't find product market fit and you're the world's best manager, you're going to fail. So you really, the only thing that matters in the early stages of a technology startup are finding product market fit.

8:40The best definition that I can give to you is based on the lean startup methodology, which was popularized by Eric Reese in his book, The Lean Startup, which was really a successor to what Eric had learned from a fellow named Steve Blank, who had written the first book on applying the scientific method to business called The Four Steps to the Epiphany. So both Eric and Steve believe that one should apply the scientific method to business. Amazingly, this was a radical insight about 15 years ago. And what they mean by that is just like in third grade, when we used to have science projects in elementary school, you have to develop a set of hypotheses that you need to test, improve, iterate, and move on.

9:31And so the two key hypotheses that one needs to test are one's value hypothesis and growth hypothesis. And they should be done in that order, value first, then growth. The value hypothesis is the what, the who, and the how. What are you going to build? For whom is it relevant? and the how is the business model that you're going to apply to attract customers. The growth hypothesis, which is pursued after you've proven your value hypothesis, are ways that you can cost-effectively acquire customers. Product market fit happens when you have proven your value hypothesis. In other words, customers really buy into your value proposition and almost grab the product out of your hands.

10:19And so you might ask, how do you know if you have it? Well, there are three heuristics that I recommend to companies. One for consumer-focused companies and two for enterprise companies. Would you like me to share those with you? Please do. Okay, great. Well, on the consumer side, you know that you have proven your value hypothesis. if you have exponential organic growth. Paid growth is of no value. You're fooling yourself if you think that you have built a great business because you paid through advertising to acquire it. The only thing that proves that you really have customers who are crazy about your product is if you build word of mouth, such that your customers buy more products and tell their friends to buy the products.

11:12And when you have word of mouth, that's the only way you can drive exponential organic growth. So unless you do that, you really haven't found product market fit because you might buy customers, but if they don't tell other people about it, it's ultimately going to implode on you when you stop spending all of that money. On the enterprise side, there are two heuristics that I use. One, I learned from a great venture capitalist named Doug Leone from Sequoia Capital. Doug, who was a great salesperson before he became a venture capitalist, advises entrepreneurs in the enterprise space that whenever you do a trial, and almost every startup has to do a proof of concept trial to get new customers to buy their product, You need to pull the trial out of the customer's hands after 30 days.

12:04So in order to qualify customers, companies typically require that they sign a contract that says, if the product does everything that we say that it will do, you'll buy it after 30 days. But very few companies are actually willing to do that. What Doug found is that unless you're willing to pay after 30 days, you're never going to pay anyway. You're just not desperate. and unless you're desperate, you're not going to buy from a startup. If there's a good enough alternative for a customer, they're going to go with a good enough alternative because it's lower risk. So at the end of the 30 days, you pull the trial.

12:41If the customer screams, you say, well, pay me. And if they pay you, you know, you have fit. And if they don't pay you, you don't. It's really as simple as that. The second heuristic I learned again from Mark Leslie, who I mentioned earlier. And he wrote an amazing article in Harvard Business Review that anyone can download with a Stanford professor named Chuck Holloway called the Sales Learning Curve. And what they found is that at the point that a company's sales teams generate contribution margin greater than the cost to field the team, you found product market fit. So that ratio is known as the sales yield.

13:24So imagine it costs on the order of five or$600 ,000 to field a direct sales team, meaning a salesperson, including all of their expenses and commissions, a systems engineer to do the technical part of the sale, a fraction of an inside sales rep who does some prospecting, and then the management overhead. So the total cost of that for a sales team is typically$500 ,000 or$600 ,000. Until a sales team is able to generate gross margin in excess of$500 ,000 or$600 ,000, you haven't found the recipe to sell and you haven't found the fit. Interestingly, once you get above that sales yield ratio of one, the ratio actually takes off and explodes.

14:12So that's a really good test for enterprise companies. Fire Nation, a lot of value here. The one that I want to focus on is consumer because I found that super fascinating and probably most relevant for most of our listeners, which is exponential organic growth. Keyword being organic. We're not talking about paid growth because paid growth is of no value. Word of mouth is everything. Are your users, are your consumers talking about your product, recommending it, being evangelists? Are you growing through word of mouth? And wow, we have a lot more value that we're going to be dropping when we get back from thanking our sponsors.

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15:23It also helps you grow your customer base with tools that helps reps anticipate customer needs before they ever become issues. With HubSpot Service Hub, reps are resolving tickets 13 times faster, helping them close 42 % more tickets per day. And that means increasing retention by more than 80%, scale support, and drive retention and revenue all in one place with HubSpot's all-new service hub. Visit hubspot.com slash service to learn how this all-new solution can help you deliver for your customers. So, Andy, for a lot of people, building a mission-driven business is of utmost importance. How can Fire Nation, our listeners here today, build a mission-driven business?

16:06I don't think every business is meant to be mission-driven. If you're building a commodity product, it's hard to be mission-driven. You have to have an element of changing the world to be mission-driven, at least in my opinion. And so for those people that do want to build that mission-driven business, that is their goal and their harsh desire. Where would they start? I don't think you can. So forgive me for throwing cold water on this, but this is actually something I talk about in my class. I think that most people who write about entrepreneurship lead you to believe that companies are started by analyzing a market, finding problems, and developing solutions.

16:50That seldom leads to a big outcome. And I'll explain why in a second. When you look at really successful tech companies, almost all of them have actually been the result of an engineer noticing an inflection point in technology, figuring that enables them to build a particular kind of product. And then they have to find a market for that product. So it's the exact opposite of what people think. So if you're sitting in your office trying to dream up ideas that you can pursue, that's very unlikely to turn into a big business. And let me give you a framework for why. May I? Please do. Okay. Well, it's actually something that I learned from my investment idol, a fellow named Howard Marks from Oaktree Capital, who's probably the premier distressed debt investor in the United States.

17:46and he's probably as well known for his quarterly letters to his investors as he is his great returns. And all of his letters are based on the same framework. And basically it is that investing can be described with a two by two matrix. On one dimension, you can be right or wrong. And on the other dimension, you can be consensus or non-consensus. Now, obviously, if you're wrong, you don't make money. But 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 big returns is to be right in non-consensus.

18:19The problem is you know you're non-consensus, but you don't know that you're right. So it is a challenging way to make money. I think the same framework applies to entrepreneurship. Starting with the market and developing solutions is something that just about anybody can do. So that's an example of the right in consensus quadrant, which seldom leads to big success. Whereas starting with an inflection point in technology, remember without change, there's seldom opportunity, which allows you to create a product and then finding a market. That's an example of being non-consensus and hopefully you're right.

18:57The mission driven companies tend to be in that right and non-consensus quadrant. And those ideas, you don't find those ideas, they find you from your authenticity to the opportunity because you will recognize that inflection point well before someone else might. So that's really, really hard to do. And I'm not sure I can advise your listeners how to do that. So a lot of people in our audience are those small business owners, those solopreneurs, the little guys and the little gals. Are we able to compete with these behemoth legacy companies? Is that even possible? If you're right in consensus, no.

19:43And what if you're not? Well, then you have a chance because then you're serving a different audience. The people that you're serving are desperate because they haven't been served by the incumbents. So you're essentially saying if you're identifying a big idea, but then you're saying, okay, within that big idea, there's a lot of competition, obviously, because it's a big idea for a reason and a lot of people are trying to solve it. Let me try to identify the void in the marketplace, the underserved problem that's not being solved and going all in on that. Again, you're starting with the market.

20:15I don't believe you can build a big business that way. Now, what's frustrating about this is that every company revises history after it has succeeded. And they change the story to make you believe that they did what you just described. because consumers prefer to buy from companies that always intended to serve them. And so everyone changes their story. Here's a great example, Airbnb. So while it didn't start with an inflection point in technology necessarily, they were just trying to solve their own problem. One of their roommates had moved out and they needed money. and a design conference came to town and they rented out one of their rooms and they were really shocked to find that multiple people would rent that room.

21:08So they tried to build a business around that but it was focused on events so it was the wrong market. They didn't change the product, they changed the market. And ultimately what they determined was that professionally photographed rooms on their site converted at 3x the rate that non-professionally photograph rooms. So they ran an experiment and started offering professionally photographed rooms for free and the business took off. Now, later on, they positioned their brand as living local. That's not what they started to do, but that's what they tell everybody they started to do. Now, they're not liars, they're revisionists.

21:52And every great company is a revisionist. Revisionist history, Fire Nation. So Andy, what specific leadership principles are crucial for success? Selflessness, number one. Great leaders put their people ahead of themselves. That's why people follow them. They're empathetic, they're transparent, and they're candid. Selflessness, empathetic, transparent, candid. Fire Nation, think about it. How many of these principles are you living? Are you acting within every single day? So Andy, we've talked about a lot of things today. And I think a lot of them are interesting because it's going to give Fire Nation a lot of food for thoughts, some contrarian thoughts and some really interesting ways of approaching things.

22:42What is the one thing of everything that we talked about that you really want to make sure our listeners really get from this conversation? Then share the best ways that we can connect with you and maybe consume more of your content. And then we'll say goodbye. The best advice that I can give entrepreneurs is don't focus on the percentage of times that you're right. Focus on the magnitude of when you are. So I would rather be right one or two times out of 10, but have really big magnitude from those decisions. Then I would be nine out of 10 with small magnitude. It's a very, very different way of thinking.

23:23Is there any place Fire Nation can consume more of your content? Anything you want to share there? Well, not about entrepreneurship, but if they want to consume my content about investing, Wealthfront has a blog that is unique in that we provide data-driven, actionable personal finance advice. Most personal finance advice is based on old wives tales and rules of thumb that the data actually proves to be incorrect. And so we basically show the fallacies of a bunch of those things. And as a result, it builds trust for our service. We integrate investing and banking to make it delightfully easy to grow your net worth.

24:09So if you want to consume my content, my content focuses on Wealthfront. Wealthfront, Fire Nation. Because you know this, you're the average of the five people you spend the most time with. And you've been hanging out with Andy and myself today. So let's keep up that heat. And if you want to check out the show notes page, head over to eofire.com, type Andy in the search bar. The show notes page will pop up with the links, timestamps, you name it, it'll all be there. And make sure you do go check out Wealthfront for all the reasons Andy just shared. And Andy, I want to say thank you for sharing your truth, your knowledge, your value with Fire Nation today.

24:44For that, we salute you and we will catch you on the flip side. Hey, Fire Nation. Today's value bomb content was brought to you by Andy and Fire Nation. If you've ever thought about creating a podcast of your own, the podcast journal is for you. It is a gorgeous full leather journal that will guide you step by step in the creation and launch of your podcast in 50 days. Visit thepodcastjournal.com. Use promo code podcast for a$15 discount. And thank you for listening to my podcast. And I will catch you there or I'll catch you on the flip side. Success Story, hosted by my friend, Scott D. Clary, is brought to you by the HubSpot Podcast Network, the audio destination for business professionals.

25:25Success Story features Q &A sessions with successful business leaders, keynote presentations, and conversation on sales, marketing, business, startups, and entrepreneurship. In a recent episode, Scott brings Kate Bradley on the show, founder and CEO of Lately.ai, to discuss the best ways to use AI to create content. Listen to Success Story wherever you get your podcasts.