20VC: Andy Rachleff, Founder @ Benchmark & Wealthfront on What Makes The Best CEO & Board Member & Why Ivy League Endowments Are The Best Managed Capital In The World

From 1995 until 2004 Andy Rachleff was a co-founder and General Partner of Benchmark Capital, who have backed the likes of Twitter, Snapchat, Dropbox, Uber and Instagram. Upon his retirement from Benchmark, Andy joined the faculty of the Stanford Graduate School of Business to teach a variety of courses on entrepreneurship. In 2008 he co-founded Wealthfront Inc, the online financial advisor and investment management solution, where he now serves as Executive Chairman. In just 3 years, Wealthfront now have over $2bn AUM. In Today’s Episode You Will Learn: 1.) How Andy made his way into the world of VC and what was the origin story behind the founding of Benchmark? 2.) Andy took the opposite route to most having been a VC and then founding Wealthfront. So what does Andy make of doing VC first and then becoming an operator? 3.) Why does Andy believe Ivy League endowments are the best managed pools of capital? What do they do well and what separates the good from the great? 4.) Andy has worked with some of the world's best CEO's and board members, so what makes the best board member and what makes the best CEO? 5.) How has Andy seen the VC industry evolve and develop over the last 20 years? How has Andy seen his own investment decision making process and patter recognition alter over that time? Items Mentioned In Today’s Episode: Andy’s Fave Book: The Innovator's Dilemma As always you can follow The Twenty Minute VC, Harry and Andy on Twitter here! The Twenty Minute VC is brought to you by Leesa, the Warby Parker or TOMS shoes of the mattress industry. Lees have done away with the terrible mattress showroom buying experience by creating a luxury premium foam mattress that is order completely online and ships for free to your doorstep. The 10 inch mattress comes in all sizes and is engineered with 3 unique foam layers for a universal, adaptive feel, including 2 inches of memory foam and 2 inches of a really cool latex foam called Avena, design to keep you cool. All Leesa mattresses are 100% US or UK made and for every 10 mattresses they sell, they donate one to a shelter. Go to Leesa.com/VC and enter the promo code VC75 to get $75 off!

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Harry Stebbings?

  Welcome to the 20 Minute VC with your host Harry Stebbings at H Stebbings on Snapchat. Now, when I started the 20 Minute VC, I wrote down the three names of VCs that out of all the ecosystem I most wanted to have on the show. Well, I'm delighted to say that today I can tick off one of those names as I'm thrilled to welcome Andy Ratcliffe. Now, where do I start with Andy? Let's start with his time in VC. So, from 1995 until 2004, Andy was a co-founder and general partner of world famous Benchmark Capital, who've backed the likes of Twitter, Snapchat, Dropbox, Uber and Instagram, just to name a few. And upon his retirement from Benchmark, Andy joined the faculty of the Stanford Graduate School of Business to teach a variety of courses on entrepreneurship.

• 0:42Harry Stebbings?

  And in 2008, Andy co-founded Wealthfront, the online financial advisor and investment management solution, where he now serves as the executive chairman. And in just three years, Wealthfront now have over $2 billion under management. And actually, before I forget, you can get an extra $5,000 managed for free at Wealthfront if you sign up with www wealthfront.com/20minetc. But before we jump into the show with Andy, if you are starting out in the investing industry or looking to make your move in, VC Unlocked really is a must. It's a jointly run program by Stanford Center for Professional Development and 500 startups. And it's a two-week crash course on investing strategies, tools and tactics for investors

• 1:25Harry Stebbings?

  who want to learn how Silicon Valley really operates. And you'll hear from some top investors, including Dave McClure, Jason Calacanis, Jason Lemkin, Mark Suster, all ex-guests of the show, I hasten to add. So do not miss out on this incredible opportunity and check it out at 500.vc/apply. And if you're lucky enough to get a spot at VC Unlocked, one thing for sure, after meeting all those amazing investors, you'll be tired at the end of the day. And no better way to end the day than by climbing into your Lisa mattress, made using only the finest combination of materials. And even better, they take the guesswork out of buying the mattress. With their universal mattress, they remove the decision fatigue and allow almost everybody to sleep better.

• 2:07Harry Stebbings?

  So check it out on leesa.com/vc and enter the promo code VC75 at checkout to get a whopping $75 off. But now it's time to hand over to the main man, Andy Ratcliffe, co-founder of Benchmark and Wealthfront.

• 2:28Speaker 01

  You have now arrived at your destination.

• 2:31Harry Stebbings?

  Andy, it's such a pleasure to have you on the 20 Minute VC. I really am so excited for this interview, so thank you so much for joining me today.

• 2:38Speaker 02

  Thank you for having me.

• 2:39Harry Stebbings?

  Now, I'd love to get the ball rolling today by hearing how you made your way into the world of VC and what the origin story was for Benchmark first.

• 2:47Speaker 02

  Well, I made my way into the venture business in an unusual fashion. I had read about the venture capital business after my junior year of college, so that was the summer of 1979, and it combined three things that I loved: computer science, investing, and entrepreneurship. My dad ran a very small business, and I thought, God, if I could work on that, that would be better than than anything I could ever imagine. And so, when I graduated college, I had studied finance and computer science. I first set out to pursue my my computer science background, but the only opportunities in New York where I wanted

• 3:28Speaker 02

  to live were not very appealing, so I pursued investment banking. I worked for someone who had gone to Stanford. He suggested I go to business school at Stanford because that would help get me into the venture capital world. I was in the venture capital business for about 11 years before my partners and I decided to start Benchmark.

• 3:54Harry Stebbings?

  And most people take the route of operations and then moving into VC. I think Guy Kawasaki said it was the optimal route, but you took the other route, and you obviously started in VC and now have moved to operations with Wealthfront. So why did you take this route? And why do you think it's optimal doing VC first and then moving into operations?

• 4:16Speaker 02

  Because I'm not very bright. It's not at all optimal, and I had no intention of starting a company. It actually happened serendipitously, which I think is the way that most great ideas come to pass. I think that great ideas find you, you don't find them. I never intended to start a company, but the idea hit me, and it was something that I needed to do for the social good of it.

• 4:40Harry Stebbings?

  So when did the idea hit you, and what was that aha moment for you?

• 4:45Speaker 02

  I retired from the venture capital business in the beginning of 2005 and I had a life that was well beyond anything that I ever could have imagined. So I wanted to spend my time giving back and I did that in the form of teaching at my graduate school alma mater, Stanford, by joining the Board of Trustees of my undergraduate alma mater, University of Pennsylvania. And my wife and I started an innovative cancer research funding initiative. As part of my responsibilities as a trustee at University of Pennsylvania, I serve on the Endowment Investment Committee. And one day I was sitting and listening to a presentation by the investment team on how they generate their outstanding returns. And I think that

• 5:30Speaker 02

  the Ivy League university endowments are the best managed large pools of capital in the world. And I was struck by how arcane their analysis methods were, that they were done in spreadsheets. And I thought, God, if you could do that in software and lower the minimums associated with the managers in which they invest, we could bring endowment style investing to the masses, which addressed a common problem I had faced over the years. Many of the people that I had recruited to my portfolio companies, who had gone on to financial success, would come to me for investment advice. And I could never advise them to do what I do, because I was in the unbelievably fortunate position to be able

• 6:15Speaker 02

  to afford access to the best investment products and services. And even though they'd made anywhere between one and 10 million dollars, they still couldn't afford access to really high quality investment services. So I thought, by putting in the software, most of what the endowments do, I could democratize access to sophisticated investment management and thereby offer a social good.

• 6:41Harry Stebbings?

  And I'm really intrigued there, just jumping on the fact that you said, you know, you thought Ivy League endowments were the best in the world and best managed. What do you think it is about them that makes them the best managed?

• 6:51Speaker 02

  They all actually pursue a very, very similar methodology. At its core, they use modern portfolio theory to do asset allocation. What really separates them is their ability to evaluate managers.

• 7:06Speaker 02

  Now, if you give a manager $200 million, you have access to a level of detailed information that's not possible if you're a small investor. Mutual funds, for example, are completely opaque. The only information you have about their investments are what they publish at quarter end, and that does not reflect what they're actually invested in over the course of the quarter. If you offer a manager $200 million, you can get all of their trades and do a level of attribution analysis that can truly help you determine who's lucky and who's good. So I think the ability to generate alpha through manager selection and the ability

• 7:51Speaker 02

  to access the premier alternative assets are what set the Ivies apart.

• 7:56Harry Stebbings?

  And moving back to Wealthfront and the democratization of online investment management, moving from Benchmark to Wealthfront to incredibly special institutions, but what was so special about Wealthfront then to you that made the transition so special?

• 8:13Speaker 02

  Well, I thought I was doing a social good. I didn't start the company to make money. I really started the company to right a wrong. It really bothers me how much the traditional investment management industry takes advantage of small investors, and there's no reason for that. I thought that I could actually do something about it, and that's what gave me passion to do something that had I understood how difficult it was, I never would have pursued it.

• 8:43Harry Stebbings?

  What was the most challenging in the journey for you? You just said that the most difficult. What was challenging?

• 8:48Speaker 02

  What was most challenging was the thing that's most challenging for every entrepreneur, and that's finding product-market fit. It's very, very rare for anyone's initial idea to succeed, and the process of iterating through a series of value hypotheses is very, very difficult, and it can be very depressing if the hypotheses prove false.

• 9:16Harry Stebbings?

  And I'm really intrigued. When do you think then, well, first, how do you assess product-market fit with Wealthfront? And when do you think you really hit that product-market fit?

• 9:24Speaker 02

  That's a question that's often asked in the class that I teach at Stanford Graduate School of Business on this subject. Consumer-related businesses, I think you know you've found product-market fit when you achieve exponential organic growth. Anyone can gain growth through paid acquisition. If you can achieve exponential organic growth, that's when you know you've found product-market fit.

• 9:50Harry Stebbings?

  And moving to the wider online investment management landscape now, it's reasonably well-populated today in our environment. So how do you view that competitive landscape, first off?

• 10:01Speaker 02

  Well, there are a lot of players, but just because they all say they do the same thing doesn't mean they do the same thing. A great example of that is Charles Schwab. They introduced a service last year that's the equivalent to what we introduced in 2011. It is in no way comparable on a net of the after-tax risk-adjusted basis to what our service has evolved to today. So there's a very wide range of capabilities. Just because everyone calls themselves the same thing doesn't mean they all deliver the same capability.

• 10:37Harry Stebbings?

  So what do you think the key differentiators will be then in this online investment management landscape that will determine the ultimate victors?

• 10:45Speaker 02

  I think it's going to be a combination of delivering the best possible investment management solution and making that solution delightful.

• 10:54Harry Stebbings?

  And when you look at kind of a reflective stance now and you look at your career in VC, and what are the fundamental learnings then that you took from that career in VC and have applied to Wealthfront?

• 11:07Speaker 02

  You know, it's interesting, very little of what you learn in venture capital is applicable to being an entrepreneur. My teaching partner in one of my classes at Stanford, Mark Lesley, the founder of an incredibly successful company named Veritas Software, he grew it to about a billion and a half in revenues from nothing, was so excited when I became an entrepreneur because he hates venture capitalists. And he was very proud that I was finally a CEO. And he said, "God, you would be such a better venture capitalist now that you've had this experience." And I said to him, "I couldn't disagree more." And he was perplexed. And I said, being a CEO, the things that make you a very good leader

• 11:49Speaker 02

  have nothing to do with the things that make you very good at finding and choosing investments. I think that it can make you a better board member. I talk a lot less as a board member since I became a CEO, but ninety percent of the value added of a venture capitalist is finding and choosing the right investments. My mother could have been on the board of Google and it would have been successful. Same thing with Facebook. So really big wins are big wins no matter who's on the board. I think being a really good board member can make the difference between a three X and a six X outcome, but that doesn't really move the needle on the economics of a venture capital firm.

• 12:31Harry Stebbings?

  I'm really intrigued there because now you've had the perspective of both. What do you think makes the great CEOs? And then what do you think makes the great board members? You said you speak less now in board meetings. So let's start with the great CEOs. What makes the great CEOs?

• 12:45Speaker 02

  I think a great CEO is someone who, over the long period of time, is able to continue to reinvent their business. Mark Lesley wrote a tremendous article about this that he published on the first round, excuse me, the first round review on the importance of reinventing your business. Every business has a phase of going up and a phase of going down. Some businesses, the phase going up is longer than others, but they're all ultimately going to decline. What really sets apart the special CEOs is they're able to layer on new businesses

• 13:26Speaker 02

  on top of the old businesses. If you think about Apple, layering on top of the iPod, on top of computers, and then the iPhone, and then the iPad. Adobe started with PostScript, which enabled what you see is what you get, laser printers, but then they added Photoshop, then they added PDF. Now they're offering a bunch of marketing tools. The really great companies that endure as growth companies over long periods of time continue to add new businesses. And that's what I think makes a really great CEO.

• 14:01Harry Stebbings?

  And you've worked with many of the truly great CEOs, and on the board, that is. And so what then do you think now you've seen boards from the entrepreneurial perspective makes a great board member?

• 14:12Speaker 02

  A great board member is one who focuses on the hundred thousand foot level because they can't possibly know the details of the business. And I think being an outsider, they can hold the mirror up to management to make sure they're being intellectually honest about their product market fit. A board member who tries to tell management what to do seldom succeeds. A board member who asks tough questions to make sure that management is being intellectually honest in their own thinking is a really valuable board member.

• 14:47Harry Stebbings?

  And I'd love to stay on the theme of reflection and look at the VC ecosystem on a macro perspective now and discuss its evolution over the last 20 years. And so what have you seen as the fundamental transformations that we've witnessed in VC over the last 20 years?

• 15:02Speaker 02

  Well, the biggest change is the transition from investing in companies that have high technical risk and low market risk to companies that have low technical risk and high market risk. 20 years ago, we primarily focused as an industry on backing companies that attempted to gain their advantage through price performance. There were examples of if you really could build what you said you could, you knew that people would want to buy their product because they offered a 10x performance advantage or 10x the storage or 1/10 the latency or 10x the bandwidth for the same amount of money. Our key challenge as venture capitalists

• 15:44Speaker 02

  was determining whether or not the entrepreneur could actually deliver what they said they could. And the reason that mattered was we knew that what killed our companies was market risk, not technical risk. If the dogs don't want to eat the dog food, it doesn't matter how good the people are, how good the management is, they're not going to succeed. Now, over the last 20 years, we've moved to a world dominated by software and software has almost no technical risk unless you're pursuing a very fancy algorithm. The challenge is that you never know whether or not anyone wants what people set out. To build. So it has very low technical risk and very high market risk.

• 16:27Speaker 02

  Market risk, as I said, is what kills investments. So the venture capitalists, the premier venture capitalists understood this transition and outsourced the early-stage investment for these low-technical-risk businesses onto the angel community. Many in the blogging community think that the angels wanted away from the venture capitalists. Quite the contrary, it's a sucker's bet. It's a terrible risk-reward because you have all of this market risk and there is no way to evaluate it. So the venture capital community, instead of doing the first round, moved to doing the second round. They were happy to pay up because the upside was just as great 20 years later

• 17:09Speaker 02

  as it was 20 years before. So let me explain what I mean by that. 20 years ago, we used to invest in companies at a $5 million valuation, free-money valuation, with the hope that it could be worth 500 million and that would generate a 20 to 30 times return. The reason it wasn't 100 was the dilution from the capital invested. Today, venture capitalists are investing at a $50 million order-of-magnitude valuation, hoping that the company can be worth 5 billion. Interestingly, there are about, just about as many companies worth 5 billion today as there were worth 500 million 20 years ago,

• 17:50Speaker 02

  which is why the premier venture capitalists are generating the same phenomenal returns today that they did 20 years ago, despite paying much higher going-in valuations.

• 18:02Harry Stebbings?

  Do you think we'll continue to see the monopoly-like characteristics of VC with your benchmarks, Sequoia's, still taking home the top returns, you know, the 1%, taking the 95%? Do you think that will continue or do you think we'll see the decentralization of VC returns?

• 18:18Speaker 02

  Well, it's happened for 40 years, so I don't see why it's going to change. And the reason that I don't think it's going to change is that... The premier firms have a form of intellectual property. No one seems to understand this. And that intellectual property is the lessons of success. So I'm a big believer that you learn far more from success than you do from failure. I think you learn more personally from failure. You learn more professionally from success. The premier firms have had the benefit of investing in a number of companies that have been very, very successful. So when a new company comes in, they know what leap of faith to take to get the return.

• 19:03Speaker 02

  Because without risk, there is no return, no outsized return. You have to take risk. The second tier firms would like return with no risk. Now, they don't know which risks to take. They just know which ones to avoid. They don't know which ones to take. And believe it or not, that is incredibly valuable intellectual property. And what I believe separates the premier firms from the second tier firms.

• 19:32Harry Stebbings?

  And when you look back at your own investment decision-making process and pattern recognition, how did you see that evolve and grow over time? And what were the kind of catalysts and key learning points for you?

• 19:42Speaker 02

  Well, the benefit of working for a great firm is you get to work with people who've done it for a long time before you. And it's like drinking from a fire hose. And you never stop learning. It's, it's really quite amazing.

• 19:57Harry Stebbings?

  And, and I want to dive into a quick fire round with you now. It's one of those shows where I absolutely hate that I called it the 20 minute VC. But on a quick fire round, I say a short statement and then you give me your immediate thoughts. How does that sound?

• 20:10Speaker 02

  Fine.

• 20:11Harry Stebbings?

  So your favorite book and why?

• 20:13Speaker 02

  The Innovator's Dilemma. Had I understood disruption theory when I was a venture capitalist, I could have done a much better job.

• 20:22Harry Stebbings?

  And then the best piece of advice ever given to you.

• 20:25Speaker 02

  Only worry about the things within your control.

• 20:29Harry Stebbings?

  And you're a mentor to many, but who's your mentor and how did that come about?

• 20:34Speaker 02

  This one might surprise you, but my mentor was one of my partners, Bruce Dunleavy. Bruce is two years older than I and he was a business school classmate of mine. The kind of person that I just knew I had to work with. So I recruited him to the, to a partnership that we both ended up working at. Prior to Benchmark, it was called Merrill, Pickard, Anderson and Iyer. And he's just the best influencer I have ever met. He's respected for his advice more than anyone that I know in the venture business. And I have learned a tremendous amount from him.

• 21:15Harry Stebbings?

  And then your favorite blog or newsletter, what's your kind of key reading?

• 21:19Speaker 02

  I don't read blogs or newsletters because they're seldom well informed.

• 21:23Harry Stebbings?

  So are you white papers from universities?

• 21:27Speaker 02

  Actually try to get my knowledge from meeting companies. There's no substitute for direct knowledge. This is something I talk to my students about. Having been written about, it drives me crazy that bloggers never seem to ask companies questions when they write about them. They just go based on public, they, they base their writing on publicly available information, which doesn't capture the truth. It's amazing to me, the number of blogs that are written about Benchmark or Wealthfront that just completely miss the point because they never call to ask. Had they asked, I would have told them and they would have done a much better job.

• 22:10Harry Stebbings?

  That's why I came to you beforehand for the content. There we go. And then I want to discuss then finally, the, the next five years for you and for Wealthfront and, and the roadmap ahead.

• 22:21Speaker 02

  Well, I think that we have barely scratched the surface at Wealthfront. I published a blog on an issue that is very poorly understood. And that's how you can tell that a new technology is likely to be very successful over the long term. If you look back at technology over the last 100 years, what you find is that every new type of technology is adopted at a faster rate than previous technologies. Examples of that, the radio was adopted at a faster rate than telephone. Television was adopted at a faster rate than the radio. The internet was adopted faster yet.

• 23:06Speaker 02

  Cellular phones were adopted faster yet, or smartphones. And if you drill down into any one of those market segments, you'll find the same thing. So for example, in passive investing, ETFs have been adopted at a much faster rate than index funds were. And automated investment services like Wealthfront have been adopted at twice the rate that ETFs have. Now ETFs today are about a $2 trillion market. So I think that automated investment services are going to be a very, very, very large opportunity. I don't think it's a winner take all business because it's not a network effect based business.

• 23:50Speaker 02

  But I think that there's an opportunity to build a really big business if you can really do a great job serving your clients.

• 23:59Harry Stebbings?

  And Andy, I look so forward to watching you build Wealthfront into the huge business that we both know it can be. So thank you so much for coming on the show today. It really was such a highlight for me to have the chance to interview you.

• 24:11Speaker 02

  My pleasure, thank you.

• 24:14Harry Stebbings?

  Wow, what a fantastic episode that was with Andy. And as I said, really was a highlight of the whole journey for me to have Andy on the show. So, so grateful to him for giving up the time today. And of course, you can get an extra $5,000 managed for free on Wealthfront if you sign up using www.wellfront.com/20minvc. Likewise, if you cannot get enough of the 20 minute VC, then you can add me on Snapchat at H Stebbings or sign up to the newsletter so you never have to miss an episode or an update from us. And if listening to Andy inspired you today to make the move into the world of investing or you would like to further your investing skills, then VC Unlocked is the Place for you is an unbelievable two week crash course jointly run by Stanford Centre

• 24:55Harry Stebbings?

  for Professional Development and 500 Startups and it will teach you the tips, tactics and strategies of some of the best investors in the industry, including the main man and good friend Jason Lemkin and Dave McClure, just to name a few. And you'll also receive a certificate of completion from the Stanford Centre for Professional Development once completed. So check it out on 500.vc/apply. But now, it's been a long day, so it's time to head to my Lisa mattress and I have to say, what makes it so awesome is not just the quality of the mattress, but also the convenience. The mattress was bought online from our studio and it was then shipped to my house in a matter of days. And this can be the same for you if you live in the US, UK or Canada. And I have to say, I love the way that they're shipped as well, as they're compressed and

• 25:40Harry Stebbings?

  then boxed, which actually helps to improve the life of the mattress. And all Lisa mattresses themselves are made in the US and the UK, so check them out on leesa.com/vc and enter the promo code VC75 at checkout for an incredible $75 off. As always, it was such a pleasure bringing you today's show. I'm so grateful for all your support and I look very forward to bringing you our next episode on Wednesday.