Chapter One

Robert Kagle

Benchmark Capital

    Since 1995, when it was first launched, Benchmark Capital has established itself as one of the industry's leading players, with spectacular results from investments in Internet companies such as eBay, E-LOAN, and Ariba. On the basis of financial returns, Benchmark's investment in eBay is one of the most successful venture capital investments to date. Their initial $5 million investment in the company was valued at well over $4 billion in mid-1999.

    The success is no accident. In an industry where few firms stand out, Benchmark has embarked on a deliberate strategy to differentiate itself. Several major university endowments and foundations are limited partners in the firm, and some of the top names in retailing, such as Louis Vuitton Moet Hennessey, are its corporate partners. The hiring of David Beirne, one of Silicon Valley's top executive recruiters, as a partner has given the firm even more attention as a major-league player. To top it all, the firm recently announced that it had raised a new $1 billion fund, ostensibly to fuel the Internet frenzy.

    Benchmark has resisted being a generalist, focusing more on technology, especially the transactional side of the Internet with e-commerce companies such as Ariba, eBay, eBags, PlanetRx, and Scient. Until recently, it stayed away from writing the high-valuation "$10 million check" to focus, instead, on smaller early-stage investments. As one of the more marketing-conscious funds, Benchmark is always sensitive to the need for public relations and the importance of branding for itself and its portfolio.

    Kagle, one of the founding partners, talks about the steps Benchmark took to quickly establish itself as one of the Valley's most prominent investment partnerships and how its focus on the Internet has paid off with spectacular returns.

    I ended up in venture capital quite by circumstance. I was at The Boston Consulting Group and was beginning to get frustrated with the nature of the work there. It was, in many ways, three months and a cloud of dust. I found this unsatisfying for two reasons. One, you couldn't see your ideas through to their implementation. Second, your relationships with clients were rather temporary. You'd be involved in all these interesting and stimulating intellectual issues and challenges, but then you would quickly be moved on to the next project. So I went to Dave Marquardt, who had been a friend of mine in business school at Stanford, for career guidance. I asked him if there were any young technology companies that he thought I would be a good fit with as a marketing executive. I've always been a marketing guy at heart--I'm really a consumer marketing junky.

    Dave introduced me to a few companies, and I would visit these companies and then come back to Dave and say, "Here's some interesting issues with these companies." After two or three of these visits, he asked me, "Have you thought about the venture capital business?" I said, "Dave, I am looking for a real job."

    The only thing I could imagine to be less satisfying than consulting was financial services. Fortunately, Dave persuaded me that the venture business was really something quite different, that it was an opportunity to combine the intellectual stimulation and the variety that I enjoyed about consulting with the ability to form enduring relationships and the real responsibility associated with making venture investments. I liked the fact that you sat on the boards of these companies and were involved with them for five, six, seven years or more. Ultimately, you could know whether or not you were doing the job by calculating the difference between the money you put in and the money you took out. So in 1983, I joined Dave at Technology Venture Investors, along with Burt McMurtry and Jim Bochnowski, and have never looked back.

Starting in Difficult Times

My introduction to the venture capital business occurred during a difficult period. Many industries had been overfinanced and there were a lot of me-too companies. It was the time when tens of disk drive companies were financed all at once. It was similar to the environment we find ourselves in today--a very capital-rich environment where fewer of the disciplines of venture capital, such as due diligence, research and the like, are being applied.

    It was a very sobering time. A number of companies were going out of business, while others were having a difficult time getting financing. It was a time when you could see what life was like on the other side. The interesting thing about the venture capital business today is that many of the venture capitalists have not seen that kind of a difficult environment. Lately, it's been really hard not to be a successful investor in the venture business. I think there are many people in the business today who don't understand what a challenging environment is, much the same way many mutual fund managers have not seen a genuine bear market.

    One of the disadvantages of having so much capital in an industry--other than financing too many competitors--is that venture companies are more prone to try a broad range of things, rather than focus in on what it is that they do best. Having ample resources, ironically, will many times prevent a company from finding its power alley, or reason for being. I've seen a lot of companies fail for lack of focus. I've rarely seen a company fail for being too focused.

    We seem to have re-entered the early 1980s in this Internet age. Some companies literally shy away from profitability, because many of the analysts on Wall Street say, "If you're showing profitability, it must mean you're not being aggressive enough about pursuing the leadership position in your segment. We want to see you aggressively invest in the marketing and branding of your service or product so that you can guarantee that leadership position. Lose money now--you can make it later."

    I was at TVI for twelve years. In early 1995 we decided, as a group, not to raise another fund together. It was a collective decision in which we, in some sense, declared victory, because the partnership had been tremendously successful. We were investors in Microsoft, Sun, and Compaq Computer. I think at one point in time we had twenty-five companies each with more than a $250 million market cap. We had a string of very successful investments. But as a group we didn't have a shared commitment to being the best in the business going forward. We also represented a broad range of generations at TVI, with Burt (McMurtry) being the most senior, and Dave (Marquardt) being next, and then me being the youngest.

Establishing Benchmark

I really felt there was an opportunity to build the best venture firm in the business, so I established Benchmark with four others who shared the same vision. Two partners, Andy Rachleff and Bruce Dunlevie, were originally at Merrill Pickard, a Silicon Valley venture firm that focused on technology. The other founding partner of Benchmark was Kevin Harvey, who was a twice-successful entrepreneur. Kevin started his first company while in college and sold it to Apple Computer. The second company he started, Approach, he sold to Lotus. Bruce was on the Board of Directors with him at Approach. The fifth partner, Val Vaden, has since left Benchmark.

    We formed Benchmark around a couple of very basic principles. First of all, I had read Jim Collins's book Built to Last right at the time that TVI was deciding to declare victory. I was saddened that TVI had been a very successful firm but wasn't going to be an enduring enterprise. Reflecting on Jim's book, and Jim's principles, I felt we ought to apply his thinking to Benchmark as we put it together, so that we could create a firm rather than a partnership, and ensure that it had lasting values. So we spent a lot of time together discussing the values and principles we were basing the firm on.

    We observed that the most successful investments in the venture capital business were in companies that were built to last. In many cases, it was the culture of these companies that really gave them this quality of endurance. What, we asked ourselves, are some things we can do differently at Benchmark to really distinguish ourselves from other funds, and to make us really unique in the venture business?

The Benchmark Principles

We had a couple of market segment insights and a couple of guiding principles. The market segment insights were that, if you invest early--if you're there at the company-creation moment--you are assured a proper seat at the table. So, we decided to focus on early-stage companies.

    Also, this was at a time when all the venture firms were raising ever-increasing amounts of money. They were raising hundreds of millions of dollars on top of hundreds of millions of dollars. We asked ourselves, can these firms afford to write a million-dollar check when it's just one guy and a napkin? We observed that in many cases they had so much money that they couldn't do the small deals. So we decided that we were not going to raise more than $100 million so we wouldn't feel pressure to put money out. In terms of capital per partner, we were going to be among the lowest in the industry. That would give us the opportunity to write the half-million-dollar check without feeling guilty about it. We went out and raised money on that basis.

    Consistent with our view that we were targeting ourselves to be the best, and the fact that we were building a labor-intensive business, we asked for a premium carry structure. We decided that, not only was it a bold statement, but if we were going to invest all this time and energy into the early-stage process, we wanted to be fairly compensated. We were able to get a 30 percent carried interest, even though we were a first-time fund--which, I think, was unprecedented.

    The second insight we had was that we felt that consumer markets and technology businesses were coming together, and that the consumerization, or democratization, of technology was going to be a very fundamental thing.

A Partnership of Equals

We founded the firm on the notion of equal partnership. We decided that we didn't want anybody at this firm to ever feel like they haven't been treated fairly. We want everybody to feel maximum empowerment. We observed that many entrepreneurs, in fact, do go out and start companies because they don't want to report to anybody. They don't want somebody else calling the shots. Every investment professional at Benchmark should have that same entrepreneurial feeling, because we are a start-up company. We need everybody to feel a sense of ownership and a sense of commitment to the cause.

    This has created real teamwork at Benchmark, so that we're constantly helping one another achieve success. We're not trying to outperform one another to get a bigger slice of that next pie. We had observed, both at TVI and at Merrill Pickard, that inequality was not a constructive situation.

    Equal partnership means totally equal in every way: same economic interest in the firm, same salaries, and an equal vote on all administrative issues. Some people, when we were raising our first fund, declared our structure a sociology experiment. But it really works, because there's a lot of joint leadership that's displayed at Benchmark, coupled with a tremendous amount of individual freedom and responsibility. I think it brings the best out in everybody.

    The only way to get financial leverage in an equal partnership is if the next guy you bring in is actually better than the guys already there. It's the only way the pie gets any bigger. That led to our attracting David Beirne, one of the top recruiters in high-tech, and our subsequent hiring of Bill Gurley, both of whom have taken Benchmark up a notch. That's a very different outcome than trying to find someone you can "leverage," and hire as an associate, or a junior partner, and make money off of while they're out doing the work. I think that is the model much of the venture business has operated on over a long period of time.

    We now have a totally flat partnership of six general partners and no associates. The way we position that with the entrepreneur is, when a Benchmark partner is on your board, you're getting a decision maker, one of the most influential people in the partnership.

    When we started Benchmark we were a start-up, so we went into full-gear hustle, and we were out there pounding the pavement like crazy, just trying to put ourselves in a position to see as many interesting investment opportunities as possible. For example, eBay came to us through the referral of its founder, who had worked with Bruce at a company called E-Shop, which TVI was also an investor in. It was a classic case of a relationship that already existed.

Venture Capital as a Service Industry

When we founded Benchmark we conceptualized our business as a service business rather than as an investment business. We observed that many venture capitalists had begun to see themselves as the center of the universe. They were the power brokers, the kingmakers, and all power and goodness emanated from them. We think the opposite--that the entrepreneurs are the people who deserve to be at the center of the universe. When we're doing our job really well, we're the stagehands and the entrepreneurs are the stars. If you have that philosophy--and you believe it's a privilege to invest in these companies--then you try to earn your keep every day by showing that you can help. That brings the very best entrepreneurs to you, because they don't want to answer to anybody, and you've got this partnership, service-oriented philosophy. If you're helping them build their companies, they're more than happy to share that information with their friends. Our best marketing tool is our list of portfolio companies.

Zeroing in on Information Technology

We focused. We decided when we started Benchmark that we would do no health care investing. Many venture firms had half their house doing biotech, and half doing information technology. We said no. We had a slide in our presentation that was a picture of those snakes with wings--the medical symbol--with a big red circle slashed through it. We said, "We don't understand what goes on in test tubes, so we're not going to pretend we do. We are going to focus all of our energy on information technology. By doing that, we're going to have more coverage in information technology, specifically the Internet, and then subsequently e-commerce, than anybody else." We've very much executed that plan.

    About a year into Benchmark, at one of our off-site meetings, we drew the conclusion that e-commerce was going to be really significant. So we, in some ways, caught that wave early, and got out in front of it. I think we have something like fifteen investments in e-commerce right now.

    An interesting thing that has been happening in recent months is that a lot of very significant brick-and-mortar companies are coming to us and saying, "We really want a partner to help us `dotcom' our business, and to build an e-commerce capability. We are not sure how to do it, and we'd like to partner with you." Some of these situations have led to relationships with our portfolio companies and enhanced opportunities for everyone.

    More recently, we've had some discussions about starting whole new businesses in partnership with large corporations that are looking to build effective e-commerce offerings, and to provide the proper incentive to recruit the best and the brightest to go do it. They have decided that to do so internally would be difficult to accomplish for cultural reasons.

Dollars and Cents

We first raised $100 million and invested that in about twenty-two companies. We invested the fund quicker than we expected to, because it was such an opportunity-rich environment. Then we raised a subsequent fund from the same investors. We've increased the amount we manage from individuals--which has been a strategic pool of capital for us--from $10 million in the first fund to about $50 million in our most recent fund; however, we've kept the institutional contributions at about the same size. Our third fund, which was just raised last fall, was exactly the same size from an institutional point of view as our second fund, at $125 million. We could have raised much more, but we decided not to raise too much capital. We don't want to have to feel pressured to write the $10 million check. We want to stay in a position to do the earliest stage investing.

    In that very first fund, we put in three times as much capital as most typical venture capitalists do in their funds. A venture capitalist usually invests i percent. We invested 3.5 percent of that fund because we wanted to show our investors we believe in ourselves as well. As a result of our investment, Benchmark was cash-flow negative for the first three years.

    But the results of our first fund have been worth it. It's a $100 million fund, and today on paper it's worth almost 100 times that. I think that the eBay investment could turn out to be the most rewarding venture investment ever--a $5 million investment that's worth over $4 billion today. You have to realize that eBay is a very fortunate experience. We aided the company's development by helping to recruit the management team and helping them sort through some important strategic issues. But returns like that don't happen very often. And, the great thing about eBay is that it's not only Bob Kagle's success--each of my partners has contributed to the company in meaningful ways, so it's Benchmark's success. Just think about how often you hear about Benchmark versus hearing about any of the individuals in the firm. That is a measure of our effectiveness in building our brand and our firm.

Early Stage, Early Tech

I would say there were a couple of principles that made us want to invest at an early stage, one of which is that it is more rewarding to be part of the company building process from the ground up. Just in terms of your emotional connection to the entrepreneur and your involvement with the process. Ariba is going to be a fantastic company, and it was started right here in our offices. Keith Krach was our first EIR at Benchmark. Before he left, he had twelve employees working here full-time, elbow to elbow with us over a four-month period. You can't buy the kind of connection and the kind of relationship that that develops.

    The most important characteristic to have as an entrepreneur? There are really two characteristics--well, maybe three. You have to have a tremendous amount of resilience, because these are very challenging endeavors. You also have to be very flexible, and you have to listen very carefully. I like to say the characteristic I look for most in entrepreneurs is big ears, because nobody's so smart as to have the right answer from the beginning. Most of our companies go through fundamental transformations between the time they're started and the time in which they achieve some degree of success. What we try to do is just encourage that process as much as we can, and to be a resource, not only as a sounding board, but also as a conduit for these entrepreneurs to connect to other constituencies that can be helpful to them in developing their plans and their businesses.

eBay--The Deal That Changed Internet Investing

Amazon was just starting to show up on the radar screen. They were a company we learned about a little too late. But, here's the insight that drove our thinking there. We looked at the Web and said, wait a minute, the Web is mostly about the ability to make a one-to-one connection efficiently. Why is it that most of the people who are using the Web are using it in a broadcast fashion--using a broadcast media-oriented model, an ad-driven model, to charge for eyeballs that are undifferentiated? Not that it doesn't make sense, but it doesn't realize the full potential of the Web.

    The fabric of the Web is really about being able to make these one-to-one connections. You have to achieve a degree of relevance to the user of the system by putting things in front of them that are of extremely high value. The best measure of that value is whether or not they are willing to transact.

    So we started to think about the Web as a transactional fabric. If we looked to where the transactions were happening, we were much more likely to find lasting and enduring online business models. It was that kind of thinking that helped us realize the value and potential of eBay when we first saw it, because here was a project that had an enormous number of page views, but no banner advertising.

    I can tell you what the revenues were then. A couple of hundred thousand dollars a month. The revenues the second quarter of 1999 were some $30 million. There's been a tremendous amount of growth in just a little over two years. What we observed was that the dogs were eating the dog food. This thing was working, it was growing organically. We weren't spending a tremendous amount of money on customer acquisition. A lot of the growth was word of mouth. You just couldn't deny the fact that it was showing a tremendous amount of vitality of its own accord. Wherever you can find natural organic growth, and you find momentum in these businesses without a tremendous amount of marketing effort, then that generally indicates that you're on to something.

    We felt that online banner advertising was probably not the promised land. But thinking about what could be the promised land led us to consider transactions as an indicator of that. Then we just started looking for the transactions online.

    There are a lot of things we look for in e-commerce business opportunities. One of the things that we like is when something is being accomplished online that just cannot be accomplished in the real world, eBay was a good example of that.

The Internet: A Transactionally Enabling Medium

The fact that the Web is an enabling medium is a fundamental element of the proposition. Another thing we look for is where the online experience can add enough, in terms of the user experience, to be compelling. We think about that along a number of dimensions. First of all, convenience. If something is just totally convenient online, relative to what you have to do in the real world, then that's very appealing to people. And, I like to use the illustration, "If the real world experience feels like a root canal, then what you want to do is find a way to use the Web's efficiency to reduce the pain."

    Online mortgages are a great example. We're investors in the leader, E-LOAN. You talk to people, and they hate the process of getting a mortgage. It's a bunch of paperwork. And there are all kinds of stages in the process where you don't know what's going on, and you're not sure exactly what you're supposed to do next. It can be a really frustrating experience for the consumer. Well, our ambition for E-LOAN is to have a product called Mortgage Now which would allow customers to apply online, get approval a day later, and get the funds a week later. That will be a totally compelling offering, not only for consumers, but also for the real estate agents whose livelihood depends on closing these deals. There's an example of a process online that looks incredibly different from the one in the real world, because it's much more convenient and much more efficient.

    The considered purchase, where the gathering of a significant amount of information in order to make an intelligent decision is necessary, is facilitated greatly online. Because in the real world you have the very separate exercises of doing the research, finding the information, and making the purchase. On the Web that can be managed in a pretty unified way.

    There are a number of businesses in the terrestrial world that have very inefficient distribution channels, have inventory spread at various layers around the country or around the world, and are turning that inventory at a very modest or slow rate. My favorite example here is luggage. We've just invested in a company in Colorado called eBags. Luggage in a department store turns on the average of twice a year. That says you have $50 of inventory sitting on the floor to create $100 of sales. Well, if you centralize and manage that inventory in a single location, you can achieve inventory turn something on the order of twenty to twenty-five times a year. You can live on one-tenth the margins the traditional brick-and-mortar retailers do, and still achieve the same level of profitability on a return-on-assets basis.

    You have to select categories where customers can be satisfied by a remote shopping experience and next-day delivery. There are clearly some things that are never going to be sold online. I don't think you're going to see many cups of Starbucks coffee sold online anytime soon. But there's a whole host of merchandise for which it will make sense to fundamentally change the distribution structure and the economics of the business to support a much more efficient and effective method of distribution. And soon next-day delivery will turn into same-day delivery.

    Louis Borders of Borders Books is launching a company by the name of Web Van. If you think of groceries and drugs and general merchandise that are brought to your door in two hours, you'll have the idea. You'll have these large distributed warehouses that will run large trucks to local depots. The trucks will cross-dock into vans, which will travel through your neighborhood dropping off your groceries and everything else you've ordered within the last several hours. It's a business where Web ordering is an absolutely pivotal enabling technology. Because if you think about it, any other user interface that you would use to collect those orders would be highly inefficient.

    I think what we're doing is stealing back bits of time that otherwise are wasted driving back and forth to the dry cleaner's. And we're giving people that time to invest back in family and community, in terms of interaction and relationships. Most of these online businesses are designed to add back time for what you and I might consider the more important things in life.

Funding Web Blockbusters

I would say that we're trying very much to stay focused on the company-building process, and on the real process of knitting together a team of executives that have the ability and the passion to build a really significant company. Having said that, the competitive intensity of these segments at the early stages is such that you can't afford not to shine the light on them in order to get early visibility and create a following for these companies. In many ways, branding is more important in the venture business now than it ever has been. And so, "mind share" is what you're trying to capture. Returns in these segments have always gravitated toward the leader. And so, there's a tremendous premium that comes from being the first well-executed play in many of these segments. What it means to be the first well-executed play is not just to execute the business, but to communicate the early success of the business, in an effective and broad way, so as to feed that success. Success does breed success in the venture capital business.

    It used to be true that the pioneers often had the arrows in their back, back in the late '70s and early '80s. I think that's less true today, although you could certainly argue that the first online services were CompuServe and Prodigy, and where are they today? But, I think that you could also take the counterpoint that Amazon.com was the first truly effective e-commerce solution for books, and they've been able to parlay that into a tremendously successful and leading business. So, being early is important, but being the best and being perceived as the leader when the category begins to become legitimized are the most important things.

Moving Forward

I think the main thing we have going for us is that we have a tremendous team spirit. We really want to be the best, and we want to be widely recognized as being the best. We want all our companies to be very happy that they did business with us, and to feel that they made the right decision when they picked Benchmark. It's really not about the money. That's one of the taglines around here. I mean, we've made more money from our first fund than I think any of us would ever have imagined having. But it hasn't changed a thing that we do. I think part of it is that we're still a start-up. In our own minds, we've still got a tremendous amount to prove to the world, to one another, and to ourselves. And, I think that we wake up every day thinking about that. It's the same kind of energy you get when you're starting a company.

    I kept telling Bruce that the only thing I would rather do than be a venture capitalist is start my own company. Well, that's what we did. We started our own company, which turned out to be a venture capital firm. But, we have much the same magic as a start-up, with people who are working incredibly long hours but yet not resenting it. They jump out of bed in the morning, instead of dragging themselves out, and they spend their time in the shower thinking about the next strategy challenge, rather than their next trip to Europe or that new jet.

    We said, "Look, it's not about the money anymore. There's money everywhere. We have to provide value to these companies. What we do for these companies has to be worth a lot more than the check we write." By thinking of ourselves as a service business, all of a sudden you're working harder to return a phone call, and you're offering to meet the entrepreneurs in their office rather than dragging them into yours. It's a subtle thing, but I do think that entrepreneurs are by and large a pretty savvy customer base. And if you genuinely believe in the spirit of partnership, you'll behave that way. That means that when really important decisions come up, you state your case persuasively, but you defer to their judgment and their decision, because it's their company. If you do that, then I think that word gets around that you are someone people want to work with.

    We're not planning to get much bigger. I'm not sure our model scales above the six partners that we have in the firm right now. So what we have to do is work smarter. We have to be more selective in the projects that we get involved with, and we have to continue to aim high and develop the full potential of the companies that we invest in. I don't think it's likely that you're going to see us raise billions of dollars, and do something radically different.

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