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February 25, 2014

Financial interaction: the next generation

I have spent over 25 years creating, processing and analyzing financial transactions. I like studying them - a lot - whether an outgrowth of my time on Wall Street helping sophisticated entities manage risks, or through IA Ventures’ investments in Simple, TransferWise, and BillGuard. Transactions are fundamentally about people interacting with other people, and are initiated at the speed of real life. But at one time or another they have to touch our byzantine, outmoded, friction-filled financial architecture, and get completed at the speed of banks. Charting the path of a transaction through the bowels of the banks and other intermediaries in our current system would require tons of boxes and arrows and round-trips that would seem absurd to the Internet-savvy crowd. This is where we are today.

Simple was founded in 2010 with the mission to offer the first truly seamless user experience to retail customers, hiding that messy underbelly of the banking world. Transparent. Low-cost. Mobile-optimized. Goal-oriented. First-rate customer service. They did a ton of things right. But in order to get up and running (relatively) quickly and with a modest amount of capital, they had to work with partners and not actually become a bank. This involved a series of known trade-offs that Josh, Shamir and the Board made with an eye towards releasing a basic product, collecting feedback, iterating on the product and creating a delightful experience for Simple users. Obtaining a bank charter was always in the long-term vision, but involves a completely different magnitude of capital, legal and consulting work - and time. Rather than innovating in a vacuum, the Simple team wanted to get a product into the wild and let users help shape the roadmap. They never could have gotten it out so quickly (and without many times more capital invested) if they had pursued the charter route.

Much has been written of Simple’s recent sale to BBVA. Separate from the impact the sale has on my firm, I personally view the acquisition as a rare example of a “win-win.” By mid-2013, Simple had grown to the point where seeking a charter was a very real consideration, but one that would have required a massive capital raise and a fundamental re-shaping of the organization due to a raft of new operational, legal and regulatory requirements. In the process of thinking about a raise, Simple received a bunch of inbound M&A interest, the most exciting of which was from BBVA. Their executive leadership had met Josh and Shamir back in 2010 and they were early believers in the Simple team and mission. By late last year, they were ready to disrupt themselves by injecting Simple’s product-focused, tech-forward DNA into their $820 billion organization. BBVA has a scale US-based banking operation, Compass Bank, which can help support Simple’s infrastructure and capital requirements in the future. Terms were hammered out pretty quickly and a deal was done. I couldn’t be happier for the Simple team that they are joining a group that really gets them, will enable them to preserve their independent and entrepreneurial spirit while providing both capital and an enlarged customer base to change the face of retail banking. However, make no mistake: Simple is optimizing the banking experience. But that experience is necessarily tethered to all that comes with being a bank, for better and for worse.

Prior to the Simple announcement there has been a bunch of stirring around re-shaping the banking experience as we know it in a more fundamental way:

In the same Twitter thread Marc went on to say:

Zac Townsend of Standard Treasury weighed in as well, subsequently sharing a write-up describing a syndicate approach to raising the capital necessary to start a bank that doesn’t run afoul of Bank Holding Company regulations. But Marc and Zac’s ideas, along with concepts proposed by several founders we’ve recently met, all share a common thread: operating within the current banking strictures. A Bank’s involvement as the centerpiece of disrupting banking simply isn’t disruption, it’s derivative. 

I believe disruption will be found by identifying the atomic unit - the financial interaction - and designing a set of user experiences that make these interactions as easy yet robust as possible. This is not limited to retail banking but involves commercial banking and investment management. And with protocols like Bitcoin (see Marc’s post on Why Bitcoin Matters) and others to follow, why remain shackled to the notion of being a bank? As the incumbents become smarter and take more risks (e.g. BBVA) the opportunity within the traditional banking sphere would seem to be muted. There’s a very high price to even play the game (call it $25 million for the charter, legal work and start-up costs, plus another $100 million for regulatory capital) and an interminable period of time that is most assuredly NOT start-up time (two years, minimum, to get all the legalities hammered out and to get up and running. And, oh yes, you need a processor and a bunch of other stuff, too). If you believe that truly disruptive alternative financial protocols such as Bitcoin will be the foundation of our financial world in ten years, then trying to re-create a better bank by connecting with existing ones or building a brand new one seems like a costly and backward-looking play.

However, I can see a place for a small, tightly-knit skunk works team of product and UX people to rapidly iterate on optimizing the UX for a single use case they’re passionate about, be it retail or commercial. They can use an enabling platform such as BancBox (I’m not an investor) to rent the pipes so they can be 100% focused on user experience. They’ll find the ‘wedges’ into peoples’ financial lives that engender trust and make people want to drop their old-line banks. And then when the landscape becomes clearer for which non-bank protocols are winning, this team can simply lay their market-tested interface on top and be a ground-breaker in the next generation of financial interaction. Now this, to me, is disruptive. The bank of the future probably won’t be called a bank. By focusing solely on making the atomic unit - the transaction - fit within users’ lives, we can avoid the interim step of building a brand new bank and skip to the good part, requiring far less expense than buying a ticket to our highly dysfunctional banking show.

If you are such a team that’s excited to figure out what people really want from their financial interactions, and have a heavy emphasis on product design and user experience, then give me a shout. It would be fun, indeed.

January 3, 2014

IA Ventures: Reflections on 2013

2013 was a very different kind of year for IA Ventures. While the years 2010-12 were characterized by 8-10 new investments per year, in 2013 we invested in only three new companies: Data Robot; Digital Ocean (DO) and Sight Machine (SM). Digital Ocean and Sight Machine were lead-managed investments (though we partnered with OATV and Mark Jacobsen on SM), while Data Robot was done alongside the leadership of Chris Lynch and our friends at Atlas Venture. We are extremely happy with our three new partnerships, and Digital Ocean and Sight Machine represented two of the largest initial investments we’ve ever made. They were many months (and in the case of DO, years) in the making, and reflected a depth of study, analysis and relationship development that we hadn’t undertaken previously. We have been experimenting with different modes of engagement with founders and their companies, and our activity in 2013 emerged from a series of hypotheses we’ve been testing. We will continue to test and refine these hypotheses in 2014, and we already have our first accepted Term Sheet to partner with a terrific founder and team in 2014 and beyond. While the work that went into studying the company and its space was significant, it happened in a far more compressed time frame than either of our two lead-managed investments in 2013. We are continuing to test, iterate, and evolve.

While we may not have added many new companies in 2013, we deepened existing relationships with several IA Ventures portfolio companies during the year. Our companies either signed or completed eight Series B and Series C rounds in 2013, as several of our largest Fund I investments continued their scalable growth and development. Consistent with the mission we set out in 2009, we are behaving just as one would expect a “conventional” early-stage venture firm to behave: utilizing our significant reserves to support the growth of our most rapidly-growing companies through Series A, Series B and sometimes even Series C rounds. This has been our playbook and now four years after having made our first investment, we are seeing the opportunities to participate in the expansion of our most mature companies multiply. It is certainly gratifying to see founders whom we believed in before there was a business to believe in succeeding at scale, and working towards the ultimate achievement of their missions. Having a front row seat to witness the maturation of founders into full-fledged CEOs managing dozens if not hundreds of people is truly awesome. As my friend Mark Suster correctly points out, the people-side of the venture business is often the most interesting and challenging part of our roles, and when you are as financially and spiritually invested in our companies as we are, there is great joy in watching things just work. 

Where will 2014 take us? Who knows. We, like our companies, will continue to develop hypotheses, test, refine and execute. We work very hard to express and act on independent thought separate from the frenzy that often surrounds us. While part of this is a function of my own contrarian biases, as a firm we have passions and interests that often run counter to prevailing thought. Selling a new approach to quality inspection leveraging inexpensive yet highly performant cameras and sensors into shop floors of manufacturers, wearing steel-toed boots and safety goggles? You bet. Leveraging a growing developer community to supply a less expensive, easier to use infrastructure platform with big-time hardware requirements? Yup. These are neither easy nor inexpensive businesses to build: capex requirements are quite significant. But we believe deeply that both spaces offer tremendous opportunities for well-built and well-run entrants, and that we have chosen great founders and companies in each space to express our views. This is what our LPs pay us for. We are working to identify secular opportunities that will pay off in a wide range of macroeconomic environments. Because let’s be real - who really knows what tomorrow holds? We can just think rationally, maintain focus, and stay within our areas of competency. Much more work to do, but we’re getting there.

December 16, 2013

"If you can’t do something willingly and joyfully, then don’t do it. If you give up drinking, don’t go moaning about it; go back on the bottle. Do. As. Thou. Wilt." 

- The late Peter O’Toole

December 15, 2013

Venture Capital and “Innovation”

Many have recently been critical of the role of the venture industry in financing “true innovation.” The narrative goes something like this: “VCs are like lemmings, flocking to the latest consumer wave (mobile chat, ride-sharing, etc.) in search of explosive short-term hits. This is not how the venture industry is supposed to operate.” This story line is further reinforced by the extreme pain felt by high-profile clean-tech investors, causing the burned to rotate away from an area of hard-science believed to be essential for the future of our planet. I mean, if VCs won’t fund these companies, then who will? Or perhaps the better question is, who should? And come to think of it, is there really only one kind of innovation, that which results in the development of a new compound or a new technology?

When it comes to breakthroughs in long time-scale, massively capital intensive areas in the hard-sciences, e.g., battery technology and solar technology writ large, I’d posit that the right source of financing for this kind of innovation is either the Government or large corporations. Why (relatively) small, private partnerships are expected to invest in generational ground-breaking science is beyond me. If you are a Limited Partner in such a fund, and the cost of commercializing one of these technologies is several hundred million dollars or more, with the possibility of the result being -0- within the stated time horizon of the fund, how could this rationally be an investment worth making? While large funds, e.g., $1-2 billion funds, have sought to underwrite these risks, even this is a paltry sum when attempting to develop a technology that is nascent and unproven relative to entrenched, well-funded and efficient incumbents. These bets have often ended in tears.

So what about VC investing in “innovation?” I’d argue that VCs have financed tremendous innovation that has either a heavy technology component or a novel business model that disrupts established players, e.g., Dropbox, Box, MongoDB, Square, Airbnb, and many others including Google, Facebook and Twitter. These companies are helping to make the world better, regardless of the fact that none of them involves cracking the atom or developing a new solar cell that changes the cost/benefit dynamics non-carbon based energy.

Does innovation need to equate to hard science? I think not. There are tremendous breakthroughs that can and have been made with a fraction of the funds required to put a man on the Moon, harness nuclear fission, or to develop transformative battery technologies to change how people interact with their devices and modes of transportation. Certain technologies can impact a broad swath of society but require the patient, deep well of capital that is simply beyond the means of private venture partnerships. These are closer to public goods and best financed by either Government agencies or large corporations with generational time horizons. Once the fundamental breakthroughs have been established, the venture community is well-suited to help commercialize and distribute the impact of disruptive technologies. But for the venture industry to be labeled as ineffective or unfairly risk-averse by not backing such initiatives simply isn’t fair. Innovation has many forms, and different market participants are better equipped to tackle certain kinds of innovation based upon their bankroll, their timeline and their mission.

Evidence is mounting that people at the bottom are increasingly stuck without skills or pathways to rise. Research from the Federal Reserve Bank of Boston shows that in the 1980s, 21 percent of Americans in the bottom income quintile would rise to the middle quintile or higher over a 10-year period. By 2005, that percentage had fallen by nearly a third, to 15 percent. And a 2007 Pew analysis showed that mobility is more than twice as high in Canada and most of Scandinavia than it is in the United States.

This is a major problem, and advocates of free enterprise have been too slow to recognize it. It is not enough to assume that our system blesses each of us with equal opportunities. We need to fight for the policies and culture that will reverse troubling mobility trends. We need schools that serve children’s civil rights instead of adults’ job security. We need to encourage job creation for the most marginalized and declare war on barriers to entrepreneurship at all levels, from hedge funds to hedge trimming. And we need to revive our moral appreciation for the cultural elements of success.

- From A Formula for Happiness, NYT 12/15/2013