The $9 billion Silicon Valley embarassment

Theranos was the bright spot for the healthcare industry. They offered low prices for a comprehensive lab tests, using only a few drops of blood. The new technology would have allowed Theranos to run tests with just a couple of drops of blood in a new handheld device. It would enable users to take their health and future into consideration. It would have created a world where, at will, we would have been able detect diseases or other conditions and take proactive steps to seek the necessary treatments.

Theranos was founded in 2003 by Elizabeth Holmes. Holmes dropped out of Stanford at 19, where she was a sophomore majoring in Chemical Engineer. By 2014, the company has raised over $100 million with investments from DFJ, ATA, Continental Ventures, Larry Ellison which valued Theranos at $9 billion. Holmes still controlled over 50% of the company, giving her a net worth of $4.7 billion and making her the youngest female billionaire.

It is now on its way to be a washout…worth $0.

In October 2015, The Wall Street Journal release an investigative report saying that Theranos did not use its own technology to do the tests. It also said that less than 10% of the tests were done with the “finger-sticks” the handheld devices that made Theranos, Theranos. The rest were done the traditional way of drawing blood from the arm. The report goes on the question the accuracy of Theranos’ lab reports. Other outlets dug deeper and many found the WSJ report to be true.

This is such a shame because the technology could have been, not only disruptive, but good. It would have made the world a better place so much so that while all the investigations were going on, no one wanted to believe it. Holmes was an inspiration and role model to women everywhere. People were rooting for Theranos, even despite all these allegations proved to be true.

The company is now facing criminal charges. Whether or not I believe that they are criminal guilty is not even relevant at this point. It is a company that is trying to do good, but ultimately went about it in a bad way. However I do believe there are going to be major sanctions. The government can use this as an opportunity to punish Theranos as an example. It is also important because of the huge technology vs. government dilemma. With Apple and the FBI notoriously duking it out over privacy concerns, and Microsoft suing the governement for data requests this is becoming a serious issue and the government wants to retain as much control as possible. After all, we all know who wears the pants in the Wall Street vs government relationship. Regulators have proposed banning Theranos, Holmes, and President of Theranos, Sunny Balwani, from the blood-testing business. This has a higher likelihood of happening than the criminal charges, especially since the company is going to be valued at zero.

Another major criticism the company has faced is its corporate governance. The board of directors consists of Riley P. Bechtel (chairman of the board at Bechtel Group), Richard Kovacevich (former Wells Fargo Chairman and CEO), Sam Nunn and Bill Frist (former U.S. Senators), Henry Kissinger (former Secretary of State), William Perry (former Secretary of Defense), William Foege (epidemiologist, former director U.S. CDC), James Mattis (General, USMC, retired) and Gary Roughead (Admiral, USN, retired). These additions all came in 2013 after the previous board members resigned. Channing Robertson (Holmes professor and advisor at Stanford), Robert Shapiro (former CEO of Monsato, Pharmacia) and Pete Thomas (ATA Ventures) left the board, leaving only Holmes, Sunny Balwani (COO and President of Theranos), and former Secretary of State George Schultz. The company then shrunk its board from 12 to 5, adding their outside counsel David Boies. Angel investor Jason Calacanis notes that the lack of a Silicon Valley presence on the board helped destruct this company as VC do proper due diligence and Theranos would not allow investors to see their technology. He says he does not consider the Palo Alto, CA company to be a Silicon Valley company. With a board full of politicians its not hard to see why he would say this, given that there is no “Silicon Valley” culture in this company.

That being said, Theranos has cemented its legacy as a Silicon Valley cautionary tale.

The Ultimate Investors

Vulture  Venture Capitalists are often portrayed as Sharks who just want a piece of your company while you do all the heavy lifting (Thanks ABC!). While it’s true that a lot of VC’s have come into money, either from being an entrepreneur (Peter Thiel – Founders Fund) or coming into money (Tim Draper – “StartupU”, Formerly DFJ). But sometimes just being a billionaire isn’t enough.

Peter Thiel, one of Silicon Valley’s top venture capitalists is no different. His fund, Founder’s Fund, just closed a fund at $1.3 billion. This puts the assets under management (AUM) for Founder’s Fund at over $3 billion. His net worth is (only) $2.7 billion according to Forbes. Yes, he has other partners (fellow PayPal founders) Ken Howery and Luke Nosek, but the three of them didn’t put all of their wealth into this fund. They are what you call managing partners of the fund. The fund has other partners, limited partners, who provide most the capital but don’t necessarily make the investing decisions.

ABC’s Shark Tank has highly publicized -and dramatized- what it is like to pitch to a VC. This is good for entrepreneurs because they know what questions they might be asked, and can really help them prepare for the pitch, with VC’s or angels, or even banks. What it doesn’t show you about the VC world is that the VC’s have to do those same pitches to potential LP’s to raise their fund.

A VC fund typically lasts 10 years, with an investment period of 3-5 years. This means every 3-5 Years they also have to go out and raise money. This  means meeting with potential individuals and other alternative institutions and pitching them on why they should invest in their fund. I mentioned the term AUM earlier in this post, but all that number really means is how successful the fund has been at raising money over time. The more important number to note is the current fund size. A mid size fund would typically have ~$100mm but as I mentioned earlier, some of the larger ones like Founders Fund have well over a billion dollars. The AUM is important to show whether or not that fund is successful un raising another fund.

Here is a great post that outlines the sizes of VC firms:
http://www.bothsidesofthetable.com/2010/04/02/does-the-size-of-a-vc-fund-matter/

So while VC’s are seen as the ultimate investors, people often neglect the fact that these investors have their own investors.This is important to entrepreneurs because even though the VC may not have been an entrepreneur, they still know exactly what you are going through when you are giving your pitch.

How Facebook Algorithmically Ruined Instagram

Instagram recently announced that they will launch a new update where your feed will no longer be in (reverse) chronological order. This seems to be the new trend for social media applications, with Facebook adopting the algorithm based news feed in 2014. Twitter also released a version of an algorithm based section called “While you were away.” Professional networking site, LinkedIn, also uses a similar method for their feed.

And I HATE it.

As a techie, I try to keep up with the ever-changing technological landscape, so naturally I tend to try out every new and upcoming social media apps. Not many of them have stuck, as I usually end up deleting the app within a week. It is a competitive space, and quite frankly most of the apps just didn’t have what it takes to compete with a juggernaut like Facebook. Admittedly, I was not too keen on Twitter. I did not see this many celebrities and public figures using the app, and frankly I wasn’t fond of Evan Williams as CEO. As the company grew (when Costolo took over), I was proved wrong. I still wasn’t a fan of Twitter, but I respected it’s simplicity. The 140 character limit allowed my timeline to not get polluted by people’s opinions that I could care less about. It was a nice contrast to Facebook, which had gotten increasingly complex, with constant updates, and doing away with wall, and introduction of news feed. The simplicity was key.

And I wasn’t the only one who enjoyed the simplicity.

Soon after, Instagram was launched. Its UI was just as simple, with easy scrolling. This is about the time I stopped using Facebook. My social media app of choice was Instagram. No more spending hours  on Facebook, constantly having a Facebook tab open on my computer. No more seeing posts of the hundreds of people I have on Facebook, and do not talk to. I just open up the Instagram app, see the few pictures posted since the last time I opened the app, from the limited amount of people I follow, and either like or comment. Instagram gained more and more users, making my experience more and more enjoyable. Then out of nowhere, Facebook buys Instagram for $1 billion.

The main reason why I liked Instagram was, like Twitter, there is less pollution of my feed. I have always thought that Instagram would have fit perfectly in Twitter’s ecosystem (anyone remember TwitPics?) where as with Facebook, it is just an adjacent entity. When Facebook, Twitter, and Instagram each announced that they were implementing algorithmic feeds, they were met with a tremendous amount of backlash. Twitter even has made the “While you were away” feature optional now. So if everyone dislikes it, why are more companies adopting the algorithm feeds?

As much as I hate to admit it, but…It Works!

My argument against using Facebook was that it was too polluted. The concept of the algorithm was to increase the quality of the content you see. My goal was to stay off Facebook, whereas the company’s goal is to try to keep consumers on their site long as possible. It also makes you miss content by deciding what it thinks is high quality content. When I do log onto Facebook, I only see a few people’s posts, so some people’s posts will go completely unnoticed. Since I rarely post, my account is prolly considered low quality for most people as well. However, the posts that I did see were more interesting to me.

This does not work for Instagram though. Instagram inherently is not as polluted. All Instagram is really just taking one photo and captioning it. Scrolling is incredibly smooth, and you can easily catch up to the last posts you’ve seen within minutes. I found myself checking the app at a higher frequency, but staying in it for less time. Also, it is easier to manage who follows you, and who you follow. Facebook has become a massive social media site, that you are connected with more people, but not on an intimate level like how it is with Instagram.

All in all, I am not in favor of this update. It does push for more user interaction, requiring you to continuously “like” other photos, and encourages to use more hashtags.  I think it is pushing Facebook’s agenda heavily on Instagram. As Facebook has to start producing revenue to satisfying investors, its attempting to continue to grow. They have gone on the offensive a lot in the last month, releasing a big update to WhatsApp, and live video updates to compete with Snapchat. This update ultimately isn’t going to have a big effect on users in the short term, but it could pose some implications in the long run, and help pave the way for a new startup to fill a void.

The Case for Convertible Debt Financing

Yesterday, music streaming site Spotify announced they have raised $1 billion from investors. The deal is expected to close by the end of this week. Private equity firm TPG, and hedge fund Dragoneer Investment Group lead the deal by buying $750 million of the deal and clients of Goldman Sachs Group can purchase the remaining $250 million.

Last year Uber raised $1.6 billion in convertible debt from Goldman Sachs clients and in December 2015 DraftKings raised $100 million in debt financing as well . In June 2015, Spotify was valued at $8.5 billion and this latest round of financing did not alter that. So why are more tech startups choosing to raise money by debt financing rather than equity?

First off, what is convertible debt? It is a bond that can later be converted into equity. So if it can become equity, why not issue the equity right away. Let’s look at the terms for the Spotify deal to understand this concept a little better.When Spotify IPO’s, TPG and Dragoneer can convert the debt into equity at a 20% discount. Every six months that discount decreases by 2.5%. Spotify will pay an annual interest rate of 5% on the debt, with that coupon increasing by 1% every six months, until the company goes public or hits the cap of 10%. The two financiers can also cash out the stocks 90 days after the IPO, as opposed to the normal 180 day lockup period.

Raising this round of debt ensured investors that Spotify would go public within the next two years. It also says a lot a lot about the startup market. First off, there is a freeze with tech IPO’s. So far in 2016 there haven’t been any. Investors are not giving as high valuations to startups. This financing did not affect the valuation of Spotify, especially in a week market. Rivil, Pandora, has seen its share price drop drastically over the last year, to the point where Spotify is valued at 3 times as much as Pandora. Issuing convertible debt allows the market to get to a better place, before converting to equity.

I think this is a mutually beneficial deal for both Spotify and TPG and Dragoneer. It is a big win for the funds because they will have an exit within 2 years and with increasing interest rates, the ROI on this investment is very positive. Spotify, which already has $600 million from previous financing rounds, adds the extra billion dollars to further compete with Apple Music, while they still post loses, without ruining their valuation and making investors weary.

Disrupting Healthcare

8 of the Fortune 50 companies are healthcare providers. Healthcare has always been a lucrative business, and even more so since 2010, when the Affordable Care Act, colloquially known as Obamacare, was signed. A new service has transformed this space into one geared directly at millennials. Oscar is an insurance company that makes buying healthcare insurance, easy, affordable, and understandable.

As someone about to venture off in the working world I found reviewing healthcare plans, offered by the company that I am going to start with soon, extremely confusing  and time consuming. Pages and pages of different plans with different words that were strenuous to even try and comprehend. I came across Oscar after reading this article in the Wall Street Journal on how they are now valued at $2.7B after closing a $400mm financing round from Fidelity. The article mentioned that Google Capital, along with General Catalyst Partners, Founders Fund, and Khosla Ventures, had invested in the company. With backers like these, I decided I had to do more research into the company.

I went over to hioscar.com to get more information and was greeted with a beautiful, simple, well designed homepage. The first option that pops up is to get a quote, so naturally, I did. It firsts asks for your zipcode, and when I entered my Arizona zipcode it said that they have no plans in my area, and are only available in parts of New York, New Jersey, California, and Texas. I entered in a New York zipcode (10005, which happens to be where Wall St. is) and new line popped up asking who I’d like to cover. A couple more fields came up, and I filled it out like this:

It really did only take a few seconds.

I was given these 5 plans and was shocked that the lowest plan was only $126/mo. After some practical thinking,I would say going with the Simple Bronze or Simple Silver would probably be a better bet. Those pricings were more on par with other insurance companies. The design was extremely simple to use and if you hover over a technical word, it will clearly define it for you (here I did yearly max, other plans have “deductibles” and other terminology).

They also offer some additional free incentives. One of the major perks is the 24/7 tele-consults.

It sounded too good to be true. Even with all of my reservations on how this can’t be possible, and there has to be some catch, if I had to buy health insurance, on my own, today, I would get it through Oscar if offered it in my location.

Upon doing more research, I found some things that aren’t really favorable for Oscar. First, and I think the biggest issue with Oscar, is that they only have partnerships with a few hospitals, and mainly just have small clinics. This means the quality of your care is compromised. Secondly, in 2015, Oscar posted a loss of $100 million. This point didn’t really bother me, as they are still a young company, looking to gain market share, however too many consecutive losses would not leave a bright outlook for Oscar. It didn’t really bother investors either, with Fidelity investing $400mm at a $2.7B valuation.

Opinion on Oscar
Oscar is a good company with potential that has no ceilings. By good I mean a company that has a positive impact for society. The major issue Oscar has is that they are not big enough. The large insurance companies just dwarf Oscar right now. As the company continues to grow and gain market share, they will be able to negotiate better contracts and reduce hospital costs. Oscar has grown from having a client base of 15,000 in 2013, to 40,000 in 2014, and 145,000 in 2015. This exponential growth would allow them to breakeven, or even be profitable in 2 to 3 years. It has the ability to be the next, more modern, Anthem Blue Cross Blue Shield.

Another option that could happen is that these big insurance companies could try to to mimic the service of Oscar. I don’t see that turning out well for the current insurance companies because it’s not really their core competency.  If they do, I feel it would turn out like what happened with Blockbuster when they tried to imitate Netflix. I feel the worst case solution would be an acquisition by one of these larger companies.

Either way, it’s a good service, and a great investment.

The Venture Capital Process – Exemplified Through Snapchat

Angels, unicorns, billionaires. Venture capital sounds a lot like a fantasy. How exactly does this mystical system work? It all starts with a problem.

“If only we had a camera [while surfing].” GoPro.
“Why is it so damn hard to get a cab?” Uber.
“I wish these photos I’m sending this girl would disappear.” Snapchat.

The founders of these companies didn’t set out to become billionaires, they found a problem and created a solution to fix it. Early investors, colloquially known as angels, didn’t know these companies would become coveted “unicorns” – a startup company whose value exceeds $1 billion.

Growth
An idea is great start, however, companies require capital in order to grow. There are two ways to raise capital, debt and equity. Debt financing are loans which require the borrowers to repay the principle amount, along with an agreed upon interest rate. Equity financing is selling a portion of ownership in that company.

This is where venture capital comes into play. Venture capitalists invest in startups with high growth potential for an equity stake. As the company’s valuation increase, VC’s make their profit when they exit the investment, either by sale of the company, or an initial public offering (IPO).

Rounds
Snapchat has raised $1.34 billion in funding since May 2012. The mobile app giant did not receive all $1.34 billion at once, but rather had 8 stages of financing. There are different stages of raising capital, and at different valuations. The first round of financing is called the seed round. This is where Snapchat raised $485k for an undisclosed amount of equity. The seed round is after the founders successfully created a proof of concept and is starting to develop a scalable product.

The next rounds are called “series.” The series A is the next stage, followed by a series B, series C, and so forth. In 2015, Snapchat raised $537.6 million at a $16 billion valuation. This was followed by an eighth round of financing (series F) in which the company raised an additional $175 million in March 2016.

Business Development
What does the company do with all this money that they raised?

Snapchat used this money to grow their business organically, and inorganically. They acquired 4 companies and we see features of those companies within the everyday use of the app.

Snapchat’s first acquisition was of AddLive for $30 million in May 2014. AddLive helped integrate video and text chat into the Snapchat user interface (UI). In December 2014, Snapchat acquired Vergence Labs which helped with advertisements and monetization and Scan, which helped in adding friends simply by using the camera to hover over a QR code. The result of this was an increase in valuation from $800 million in the series B round in June 2013, to $10 billion in December 2014 when they closed the series D round. In September 2015, Snapchat acquired Looksery for $150 million in an effort to increase monetization once again. Looksery is a facial tracking software which we see used in the new wacky and fun filters. Snapchat had planned to sell certain filters for an additional source of revenue.

You can find more in-depth funding information for Snapchat here: https://www.crunchbase.com/organization/snapchat#/entity.

Evolution
With the new business developments, Snapchat has come a long way from being a “sexting” app. It has grown to be one of the forerunners in messaging apps. It has come a long way from an app that disappears photos within seconds. Now users can send text messages to each other, and post on their “stories” for their followers to see what they are doing in real time. Snapchat also introduced “live stories” which helped in the globalization of the app. Live stories allow users to view what is going on in the world, adding a new level of connectivity between users.

Entrepreneur and VC Mark Suster highlights more uses in a post on his blog, Both Sides of the Table.

Importance of VC’s
Venture Capitalists play a pivotal role in growing and scaling a company, allowing the company to reach heights generally unattainable by startup companies or small businesses. Their investments are mutually beneficial. VC’s offer guidance and connections that you can’t find in debt financing or crowdfunding. Not all money is created equal, and finding the right source of capital is important in turning an idea into a unicorn.