"Great Entrepreneurs have a learn-it-all, and not a know-it-all approach"

Peter Fenton was told by his dad that he had all the traits to become a successful venture capitalist – he was obsessed with learning, was hyper competitive and was empathetic. His dad was not wrong. Today, Fenton is one of the most successful technology investors who has made winning bets in both consumer and enterprise businesses. Fenton backed Twitter when it was just a 25-member company and even now continues to be on the board. In 2014, three of his enterprise companies – Hortonworks, New Relic and Zendesk – went public, joining the billion dollar valuation club. Over the next three years, Fenton expects to see some breakout IPOs in the open source space.

>> Venture capital is all about betting on the entrepreneur. What do you look for in an entrepreneur?
I asked this question to Paul Graham, who runs Y Combinator, and was struck by the resonance of his answer with mine. The first quality in any entrepreneur, which is visible in the first 90 seconds, is authenticity. You need to have a solid foundation and confidence in what you are doing. Majority of entrepreneurs we meet are unfortunately promotional.  It’s a gut feel and I felt it, for example, with Travis at Uber or Evan at Snapchat. These are great examples. If you met Evan, at age 21, the intensity of his belief in what he was building was captivating. Secondly, I think the trait that great entrepreneurs have is fearlessness or fearsomeness. There needs to be something crazy in terms of recklessness, intensity and irreverence. Paul describes it as fearsomeness because he says that he needs to feel nervous about this person. A lot of great founders are dropouts. They don’t necessarily want to get grades in a system, which they didn’t create. Getting good grades in a system that you didn’t create can become more embarrassing because your subject is somebody else’s domain.

The third trait is a mindset that I look for in an entrepreneur — a learn-it-all, and not a know-it-all, approach. I think it is a remarkable trait that is common between the very best people, be it Mark Zuckerberg or Jack Dorsey or Evan Spiegel. They are effective critical thinkers; they are constantly asking questions and listening to those. That drives their long-term success.  As a potential investor, I find them interrogating me as much as I am interrogating them. Without being offensive, they will ask me questions like ‘What is it about our business that you like?’ or ‘Tell me why you think that is interesting?’ Beyond this, there comes a personality trait. I have been doing this job for 19 years and I ask this basic question ‘Would I want to work for that person?’ A lot of what we are doing is recruiting. There are a lot of people who tick the first two boxes of authenticity and fearsomeness, but for the lack of choice of words, I would say I find them unappealing to work with. We were lucky to spend time with Jeff Bezos, who is a big investor in our fund. As part of that, we get a dinner with him every year. Of course, there is a survivor bias, but these dimensions are crystal clear in great entrepreneurs like him.

>> Is it difficult being a venture capitalist these days with so much information, deluge of capital and a lot more firms competing for the same set of companies?
On a relative basis, the venture capitalist business today is harder than what it was, earlier in my career. It is a business that is defined by shoe-leather, hustle, energy and intensity. It is one of those few careers where the older you get; your probability of success goes down. So, after two decades in the venture capital business, you are less likely to find the next Google or Facebook. There are number of possible reasons for that. Success, in a venture business, can imprison you in your current board commitments. Second, success can lead you to believe wrongly that you have some special divine gifts of being able to make the companies you invest in successful. The reality is that you play a small part. Third, as you are successful, you have an image that great entrepreneurs will come and find you, which is just not the case; you need to go find them. That energy and motivation to be outbound is something that success can work against because your calendar is filled with people who want to meet you rather than people you should be trying to find. Success creates diversions and distractions that take you off the core discipline. Business, in itself, is an activity contest. It is about the number of hours you invest along with intensity and hustle that you put into it. The minute you back off, you degrade quickly. If you are not passionate about your job, you won’t sustain in this career.

>> You have said one of the great moments in any venture capitalist-entrepreneur relationship is when the investor asks the question everyone realises needed to be asked. Could you give an example of the companies where you did ask the question?
We don’t see around the corners but through high situational awareness, we can see a potential problem. Take the case of Zendesk. It has done well globally. What we had to do with their business was to evolve the management team.  Zendesk had a low-touch, high velocity business model and what we realised was that there were bigger companies who wanted to buy that product. So, we had to structure the company to sell this product to a large-scale organisation. Uber uses Zendesk with thousands of agents. We had to develop the product to support that. 

One of the forefathers of the venture business and founder of Kleiner Perkins, Tom Perkins passed away recently. I remember once he pulled me aside and told me that in this job you need to know only three things — strategy, structure and staff. In the board, you should really be clear about the strategy of the company. Strategy is not a McKinsey or a Bain report; it has to be expressed in a simple form that articulates competitive advantage. This competitive advantage is generally lost. In emerging markets, I found that this aspect of competitive advantage is a secondary or tertiary concern; revenue growth seems to be the dominant. If you see the five forces of competitive advantage in (Michael) Porter’s book, it is like an X-ray machine into the long-term sustainability of the profit model. It flows from the segment, which you were aiming to serve. Secondly, the organisation has to be designed in a way to fulfill this strategy. To be a low-cost provider, you need to have functional excellence. If you want to be a highly innovative, high margin company, you put more energy into vertical integration, do something that is feature-rich as opposed to simple and fast. The organisation design has to reflect the strategy and embody it. And finally, an organisation has to spend time on the quality of its people. It all depends on whether we have the right people and the right voice. So, what most of venture capitalist firms do is to recruit. 

>> If venture capitalists indeed asked the question that needed to be asked, then most businesses would be built on solid unit economics. But that’s not always the case.  How important is it to get the unit economics right? 
Any investment thesis needs to be built around a sustainable and durable competitive advantage. It should eventually resolve to a business model with an attractive margin profile. When capital is free, it is relatively easy for any company that can demonstrate revenue growth to raise money when the scrutiny on unit economics has been relaxed.

To go deep into the unit economics of a business, we don’t build models or rake entrepreneurs over the coals; we get to the essence of it. For instance, in a software company, I always ask the question, can you create a positive economic model in open source? Is there something people would pay for on a pro-server or pro-host basis? It is more elusive in the consumer business because there is price elasticity. The problem with consumer business is that there is a radical change in consumer behaviour when price drops. That is the challenge that Uber is up against. Unit economics is great unless you are in a market where incentives corrode them. The game on the field is not necessarily the game that you aspire to have, and that is unit economics, which doesn’t have such high competitive pressure. When capital is free, we have to struggle with it. Uber exited China because the unit economics and the expense of being there would eventually erode the value of customers. Both companies would have exhausted all the available capital on earth to pursue that market and we would eventually lose service. Now, it gets to a more rational place. 

>> You are probably one of the few investors who focus both on the consumer as well as enterprise business. What kind of advantage does that give you? 
I think, to be a great investor, you need to do both. I might be alone in thinking so, because my partners would say it is better to focus and specialise. I believe we can benefit from cross-pollination in all aspects of our lives. You can help your enterprise company learn from the growth dynamics in consumer and apply incrementalism to problems, rather than having a wide-eyed approach towards growth. You can be more appealing as an investor, if you have a broader array of experience and sectors to draw from. You need to understand what is going on, and that is what I aspire to do.

Consumer businesses are little less mechanical and have a more nuanced approach in both product design and its development. This is why Twitter is very different from Airbnb. E-commerce turns out to be more mechanical. A lot of it depends on the CEO’s ability to understand the sensibilities of what consumers want; this will have a huge impact on the underlying success of the product. Contrastingly, it is more determined in the enterprise business. You know companies need a certain X, Y and Z; so, you build that. You have more control because you know you are building something that people are going to pay for. Most stress in a start-up comes from lack of control. Enterprise businesses have more control. What they don’t have is the amplitude of success that consumer companies have had. If you take the last decade or two, all $300 billion market cap companies are consumer enterprises. We have a $50 billion market cap company in Salesforce, which has been a great success in the enterprise space in the last 20 years. But that’s one. There are a handful of companies in $10-15 billion market cap; Workday is about 20 billion. Then, you have some $1-3 billion companies. Typically, in an enterprise business, if you are successful you are likely to be a $1-3 billion company but if the consumer business is successful, you can go on to scale to around $100-300 billion.

>> When do you see enterprise companies enjoying a similar amplitude of success that some of the consumer businesses have seen?
My strong conviction is that in the next three years, we will see a number of really big breakout IPOs in the open source space. Benchmark’s first investment in open source was Red Hat in the late 1990s; and now, it is a $14 billion market cap company. We made a dozen investments including MySQL, JBoss and SpringSource. While all of them were successful, the only breakout was Red Hat. We started investing in open source because earlier, for every dollar we invested in the enterprise business, about 70 cents was going towards selling the product. Companies like Facebook, Twitter or Google spend zero dollars on convincing customers to use their product. Even Uber spends zero dollars on that kind of marketing. So, the insight was that because of the internet, you can get rid of the whole distribution chain between the author of the product and the user. What open source effectively allowed for is a new production model software, but importantly, it brought about a new distribution model where you can go straight to the source either through GitHub, or to an open source provider. By dislocating and eliminating the middleman, we can create more quality and transparency. So now, instead of spending 70 cents on distribution, you can spend that on engineering. And once you have underlying consumption of the open source product, you can build extensions to the core business model. These could be selling advanced features in the packaging business model, something which Red Hat and Hortonworks has done. We have about six possible investments coming up in the breakout category and those include Docker, Elasticsearch, Confluent and CockroachDB. By 2020, we will hopefully have three to five large open source companies.  

>> In its decade-long existence, Twitter has been in a state of chaos with leadership changes and lack of clarity in strategy. How can it be turned around?
I believe we have made every classic mistake in the book — everything from excessive management turnover, drifting strategy and lack of clear priorities. All those factors that could have easily killed most normal companies haven’t killed Twitter.

When I look at Twitter’s journey, critics ask whether Twitter is the next Yahoo? Yahoo did not have a network effect, Twitter does. Yahoo was not on mobile while Twitter was fundamentally born on mobile. Any influencer in the world is on Twitter, which makes it easier for them to strike a conversation with their audience. What more of an empowering service can you think about! You can not only connect with these people, but also interact with them directly. The management has however, talked about it’s downside. The insidious abuse of the platform needs to be addressed systematically; something that Twitter has not yet dealt with.

Twitter has a broad array of use cases, but what it has done over the decade is to serve those use cases broadly. Twitter is currently crystallising its focus. The team has realised that just by serving the core use case of news and in giving people what they want, there are a number of possibilities. We are just scratching the surface. So, it is a great opportunity to execute the potential that is in front of the company. I think, over time, Twitter has the opportunity to be bold in what it does. What the company is doing around live feeds and videos is very disruptive in a profound way. But the core utility of what the service does is something that the world can’t live without.   

What defines character is how you react when the core fundamentals are at odds with the sentiment. Although the sentiment around Twitter has become negative, they are visible. The flipside is when fundamentals are weak but there is a positive sentiment. This was the case of Zynga or Groupon; not with Twitter. You can’t turn something around with one bold stroke; it has to be done with sustained effort. Twitter is clarifying it’s focus and reducing the number of things it is doing. It is critical for the company to change and that is visible from its leadership.

>> In the past, you have spoken about product model-business model resonance and how a certain usage of a product can open economic opportunity. Google is a perfect example of that? Does Twitter have the same resonance?
That’s an interesting question, but I have to be careful on what to say because when you are on the board, you are duty bound to not get ahead of the company’s strategy. The product and the business model of Twitter had resonance right from the beginning. Even out of its first 100 million accounts on Twitter, a meaningful percentage of them had commercial intent. There was a desire to use that network to reach an audience. You can see the commercial intent of individuals with a brand they want to build — from a company to a customer service. The ad unit is a tweet. It is not a separate banner around its side and feels like it belongs there. I think this is a possible future economic model of the company, which it hasn’t pursued. They have publicly spoken only about direct response. Through direct response, you can go deeper in e-commerce, transactions and subscriptions.