When we established Social Capital in 2011, the goal was to develop meaningful solutions to meaningful problems — which is why we started with a focus on healthcare, education and financial services. They are areas that we believe share a common trait: a critical part of humanity’s infrastructure that had not sufficiently benefited from the broader advancements in software. The byproduct was a world that was advancing rapidly but increasingly asymmetric — favoring the few at the expense of the many.

The motivation to do this was also quite personal — an abiding belief that many more people could accomplish much more, had these systems been working coherently for them.

Accordingly, I did what I could to jumpstart our work, committing as much of my capital as it took to achieve our mission and giving our team the courage to incubate and invest in solutions to hard problems overlooked by the vast majority of the investment community.

Looking back over the past seven years, I believe this approach has proved successful. We have worked alongside great teams to build solutions to hard problems like diabetes (Glooko), precision medicine (Syapse), climate change (Aclima), internet access (Swarm), reforestation (DroneSeed), education (Brilliant), urban planning (UrbanFootprint) and financial inclusion (Ezetap). Alongside these incubations, we’ve made startup investments in Slack, Intercom, Saildrone, Groq, Carta and many others that have enabled the growth and expansion of technology around the world. Together, our holdings in many public and private companies have created a portfolio that is performing very well.

Our public fund returns rank in the top 5% of all hedge funds globally according to Morgan Stanley and, collectively, our four private funds have beaten our peers’ returns by 32%, on average, according to Cambridge Associates’ VC benchmark.

As far as the business of investing goes, Social Capital was firing on all cylinders. We were the second fastest firm in our industry to pass $1B of assets, was managing more than $2B of capital, and investors were clamoring to get in. However, as the firm grew, I found us incrementally drifting away from our core mission and our strategy was increasingly that of a traditional investment firm. It became harder to take the risks we took in 2011 and it became easier to play the same game as every other VC — raise a fund, collect fees, manage limited partners, deploy the capital in obvious things, rinse, repeat. While this is a very reasonable path for most people, it wasn’t right for me and my core team.

By the summer of 2018, we had finished a detailed examination of the many ways we could expand; a thorough process that gave us clarity on what was most important to the organization — it wasn’t about raising more money from outsiders but rather executing on our mission without any constraints related to sector, geography, asset class or timeline.

When making critical decisions I’ve learned to take our time, ignore the noise, be emotionless and always be data driven. This framework has led to the right outcome many times even if it looked “foolish” at the beginning (starting Social Capital, buying the Warriors, buying Bitcoin, investing in Amazon, etc. etc…).

This is the next decision along this framework and brings us to today and how we intend to iterate Social Capital. We are no longer accepting new outside capital. By the end of 2018, we will have finalized a set of changes we began in 2017 and will become a technology holding company that will invest a multi-billion dollar balance sheet of internal capital only. Solving hard problems is what we started to do and solving hard problems is what we need to do more of. This requires a radical form of self-belief — not necessarily about our ability to solve them but in our desire to commit ourselves to the long, sometimes uncomfortable path towards progress.

At its core, Social Capital is returning to our founding principles — an organization that identifies hard problems and assembles experts, IP and experiments that allow us to learn about these problems deeply. Once we have conviction about a solution, we will then execute — by building and/or buying what it takes to solve the problem we identified. Rest assured, we will continue to make new investments — $50M–250M per company — and will focus our efforts on businesses where we can make a difference, in keeping with our mission and values. Importantly, we will continue to support our existing portfolio with capital and growth services as before. Our team will be there to help drive growth and our balance sheet can and will support follow-ons for companies that are tracking.

Making these changes will allow us to reprioritize operational discussions of investment rounds, dilution, cap tables, etc. in favor of technical discussions about ideas, problems and solutions.

But mostly, these changes will give us the freedom to pursue our mission without any distractions, work on the problems we have prioritized and do so for decades if that is what it takes to solve them.

I am proud we keep taking risks and have not gotten comfortable. I want to thank the team that has helped get us here and put us in a position to begin this next chapter. Several Partners have left Social Capital to join other VC firms or start their own while several more are in the process of doing so — I am proud to see them use our platform as a jumping off point for their next adventures and I wish them the best of luck.

I want to thank our limited partners who have entrusted us to be good stewards of their capital. I have always been the biggest investor in our funds and have managed your capital the same way I managed my own.

Finally, and most importantly, I want to thank the great entrepreneurs who are working tirelessly to improve the state of our world. It may feel, at times, that you are alone, but you are not and we will increasingly show up when you need us most — unconstrained and risk-on.

With respect,

Chamath

Since our founding, we’ve never stopped searching for better and better ways to help entrepreneurs win. To do this, we’ve consistently challenged ourselves to explore what the future might look like. By definition, the future may be radically different from the present way of doing things in Silicon Valley. In my post from a week ago, I talked about the product bets we’ve placed that have started to deliver powerful results that we’re now doubling down on — including tools like CaaS to help us find great companies as well as software and services like 8-ball to make them even better.

In parallel to investing in product and engineering talent to build out the Social Capital Platform, I also kicked off a process to test if a traditional approach to scaling our asset base should be part of this solution. It seemed like a reasonable path in the era of Softbank’s Vision Fund and Sequoia’s rumored mega-fund. To execute this, I brought on two leaders: Marc Mezvinsky as Vice Chairman to lead our capital formation efforts, and Tony Bates as CEO of Social Capital Growth. We also explored what a Credit fund that could provide an entrepreneur with less dilutive forms of capital would look like.

We felt emboldened to try all of this because of our track record in venture capital. Our venture capital funds are at the top of their class and there is little doubt that some of the startups we have backed will redefine this current generation of tech companies. If there was any time to pursue these new strategies, it was, in my opinion, now.

Friends and mentors told me blindly scaling our asset base would distract me. Focus on technology, they said, and stick to what makes you unique vs what makes you the same.

I initially thought they were wrong. And so we embarked on trying to do both: build great products and scale assets across multiple new funds, all at the same time. It’s this last factor that is hard. Ironically, we tell our entrepreneurs all the time to do one thing really well, but found ourselves not following our own advice.

As I internalized this and we got closer to closing some of these new strategies, my gut was telling me to go back to our core. It took some time, but we decided not to pursue the Credit effort, and also to refine our Growth strategy to largely focus on later stage investments in some of our best portfolio companies rather than generically compete in increasingly excessive growth-stage auctions.

Refining our Growth strategy to what will be our second Opportunities fund means there is little point in having a separate Growth leadership team, because doubling down on proven winners from our venture funds is best carried out by our venture partners, since they know these remarkable companies and their founders better than anyone. As such, with this shift, the scope and roles for Marc and Tony became very limited compared to what they and I had originally thought, and we collectively came to the conclusion that it makes sense for them to transition to new challenges and opportunities outside of Social Capital, although we’re exploring ways they can still be involved in our future success as Board Partners or advisers. (Update: I want to clarify that Marc and Tony were my partners in refining and focusing our strategy and, given that direction, independently made the decision to transition into Board Partner roles. Tony will also remain Vice Chairman of Social Capital Hedosophia Holdings. I am grateful to them both for their continued leadership and am excited to have their ongoing help and insights within our portfolio companies going forward.)

It is tough to part ways with great colleagues like Marc and Tony. I am grateful to have had the opportunity to work with them, and know they’ll go on to do great things — they are A+ and I’m sure we will work together again in the future.

For the foreseeable future, we will stick to what we are truly passionate about: high-touch venture investments and building out our Platform that provides these entrepreneurs with tools and software to build better companies.

The good news is that what we are passionate about is also what we are best at. Our data-driven tools and platform technologies are gaining increasing traction, with CaaS especially promising. Our way of looking at businesses is quickly become industry standard. It’s time to double down on all of these things. Said differently, I have realized that excellence doesn’t necessarily come from the novelty of a constant stream of new things, but rather focus and refined repetition of the things that are at the very core of our organization.

One of our core values at Social Capital is having an “appetite for change”. We are continually challenging ourselves to make difficult decisions in ambiguity, and to have the courage to change our minds and course correct, with the knowledge that the path to achieving our mission is non-linear. Oftentimes we get these decisions right. But sometimes we get them wrong. And in these moments, it is really important to shine a light on them so we can learn for the future. I am grateful to the Social Capital team and our LPs for navigating this shift with their customary support, focus and determination.

I also want to personally thank Marc and Tony for their contributions. And I hope you continue to follow our journey in complementing the traditional high touch venture investing model (which we remain committed to and passionate about) with increasing levels of automated tools and software to empower entrepreneurs to achieve their goals.

Onwards.

If you’re a student of technology companies, you’ve heard this adage many times. That, ultimately, you must disrupt yourself. Because if you don’t, the winds of change will set upon you and you will be rendered obsolete. It has been true for a multitude of technology companies big and small, and technologies important and not. The lesson from all of this is that you must always question where the world is going, place small bets about what the future could look like but then have the courage to follow through on some of these bets when the data says so.

Over the past seven years, I have seen firsthand that we’ve built a strong brand at Social Capital — known for investing in great companies including Slack, Groq, and Saildrone. In many ways, there is a credible claim to make that we’ve created a top decile brand in venture — in my opinion, one of three in the last 15 years to have done so (a16z and YC being the others). Along the way, we have also had the courage to incubate solutions to some very hard problems like diabetes (Glooko), low-cost telecommunications (LotusFlare) and city planning (Urban Footprint) — with success there as well.

But I have always felt that this wasn’t enough. Specifically, I couldn’t stop questioning whether the model of venture capital was fundamentally too reactive. And, as such, broken:

• Waiting for “differentiated dealflow” is increasingly antiquated in a world of YC and AngelList — it seems like every great company is now widely known in real-time and creates an auction as soon as practicable for every fundraise — a growing advantage to the entrepreneur and a decaying advantage to venture capitalists.
• Sitting idly on boards hoping they IPO seems increasingly ineffective with competitors chasing every idea — more work than ever needs to be done at an operational level to help companies become successful in the face of enormous amounts of capital funding innumerable competitors.
• Being anecdotal in running a company is becoming destructive in a world of machine learning, data science and AI where the right answers are more knowable than ever before.

All of this led to a realization that we must disrupt ourselves if we are supposed to stay relevant. We need to move towards a more proactive form of capitalism. If we don’t, I worry that competitors that we don’t even think are competitors today will come out of the woodwork and disrupt us in the business of helping entrepreneurs. Some speculation about what this might look like:

• Every large Internet company could enable startups to get capital from their balance sheet in return for building on top of their platform(s).
• Data analytics companies could create a “learning cloud” where any company could benefit from the mistakes and learnings from other companies by sharing their operational data.
• Capital markets will capitulate to lack of returns in other areas and enter venture capital with a vengeance, flooding it with cheap money creating innumerable numbers of competitors for any idea — we already see this indirectly when you look at average deal sizes and average fund sizes.

With that in mind, over the past 18 months, we’ve been making several small bets at Social Capital including Capital-as-a-Service, 8-ball, Anther and IPOA to help us figure out what a future of “proactive capitalism” could look like.

• Can we build tools to help our team make better investments?
• Can we build software, machine learning, and data science based models to help our companies operate better and be more successful?
• Can we use new kinds of capital to help accelerate winners?

As it turns out, these bets are starting to work. The implications may not be clear yet to the rest of the industry, but they are very clear if we are to question and shape the future of Social Capital.

To have the impact we seek, we now need to double down on some of these bets — because the product-market fit and data is increasingly there. At one point I thought the best way to do that might have been through following the old playbook of gathering AUM — raise as much money as possible in as many ways as possible and invest across the capital cycle of both equity and debt. But not only will this path distract from a product-centric approach it can cause culture drift towards an organization that is not sufficiently technical — accelerating the risk of disruption vs minimizing it.

Said differently, I have realized that even when capital is widely available to us, it won’t protect our franchise in the long term from the threats described above. Scaling through technology is the only path and building valuable products is our only protection. This path will be initially harder but the result should be a more resilient organization with repeatable value to offer our ultimate customers — the entrepreneurs who are trying to improve the world.

More to the point, it means becoming a more product-oriented culture and an organization that is even more mission driven and technical. This was a critical realization to come to as the solution could have been very different. AUM vs impact. Funds vs tools and software. Luck (aka beta) vs skill (aka alpha). Instead, I now think it’s time to see if a model of proactive capitalism accelerated by technology can compete with and eventually overtake the existing model of reactive capitalism.

To make these changes, we must actually do fewer things, but do them better. Be more focused, more audacious and invest more than ever in engineering, product, data science and portfolio operations to give entrepreneurs the tools and services that can help them win — in a repeatable and predictable way. It doesn’t mean we stop the traditional model — in fact, we will continue to invest through our private funds and public funds but it does mean that we must amplify how we plan for the future and set the stage for the new model to overtake the old model — especially as the data says so.

Over the next few months, you will see us accelerate some of these new efforts and push them to the forefront. This change may be hard but necessary. Fortunately, we have a legacy of some very profitable and successful venture funds that allow us to do this. Ultimately, this work will also align ourselves more deeply with entrepreneurs and give us a chance to be paranoid enough to not just survive but thrive.

I hope you read this with excitement and anticipation for what this means — personally, I’ve not been more excited. We will share more details in the coming weeks and months…

Chamath

For all the credit the tech industry gets for making things cheaper, faster and better, there remains a growing list of of critical, real world problems that are still largely unsolved, and in many cases, getting worse. The sustainability of our cities is at the top of that list.

For the first time in human history, cities are home to more than half of the world’s population, and the work that happens within them represents 80% of global economic output. And yet underneath the hood of some of our greatest cities, you’ll often see unimaginable poverty, insufficient housing, transportation gridlock and poor air quality.

You’d think the magnitude of these problems would signal massive economic opportunity to entrepreneurs and investors alike, but Silicon Valley’s contributions to cities have been, thus far, ad hoc at best. The tech industry is great at going from zero to one: creating something where nothing existed. But cities have people and policies and centuries — even millennia — of history to contend with and work within. Solving the problems of our cities will require collaboration, nuance and patience.

We need a new approach to fixing our cities, one where Silicon Valley plays a role in partnership with the public sector, policy makers, urban planners and environmentalists.

To that end, I’m thrilled to announce our work with 100 Resilient Cities (100RC), an organization created by The Rockefeller Foundation to help cities around the world become more resilient to the physical, social and economic challenges of the 21st century. It is today’s unequivocal leader in driving global urban resilience. 100RC combines local action, including Chief Resilience Officers in cities that manage risk and plan for the future, global influence that incentivizes policy makers and financial institutions to fund resilient development, and solutions — the tools that underpin these shifts. This is where Social Capital will contribute its expertise.

With this collaboration, we’re bringing up to $150M in capital commitments to invest in startups that are building tools and solutions to solve urban infrastructure’s most pressing challenges.

We’ll work hand-in-hand with 100RC to identify the most pressing problems and their possible solutions, then test ideas together before incubating or investing in companies that fill the gap. In these early phases of development, 100RC will pilot the proposed solution with up to ten carefully pre-selected city partners, providing an invaluable opportunity to bring real, practical technology products to cities so that millions of citizens stand to benefit. Throughout the growth cycle, companies will benefit from 100RC’s expertise, which will help them see around corners and find successful fit within city landscapes, while we actively support the right team, product and business model to nurture long-term, sustainable businesses.

In 5 years, we think we can see tangible success:

• Presence in 100 cities worldwide
• Influence the highest level of policy decisions for increased resilience
• Impact 25 million citizens in 20+ cities with improved environmental and living conditions
• Access transparent insights at the local level with anyone doing business in or with cities

Put simply, we are working to help bridge the gap between what cities need to build resilience and improve quality of life, and the toolbox they have to do it.

Our Commitment to Cities was originally published in Social Capital on Medium, where people are continuing the conversation by highlighting and responding to this story.

Now that we are beginning a period of self reflection about Silicon Valley gone awry, I would like to add something important to the list. One of the biggest reasons we don’t have good governance in Silicon Valley startups is how the industry views the role of the investor and how we, as investors, stoke the flames purporting to be prescient fortune tellers vs respected advice givers.

As the Uber saga shows, investors at their best stand for decency, governance and logical management. One of the best examples of this is my friend Bill Gurley who just demonstrated what this looks like. The problem, however, is that we ascribe too much credit to the act of “picking” as represented by simply sitting on a Board vs the actual process of doing the job.

Why do we focus so much on “picking”? Because we have things like Forbes’ Midas List that glorify fortune telling.

What do you think a list like this and the voyeurism that it creates does in the minds and actions of investors and the LPs who invest in their funds? Well, the investors pretend they are fortune tellers. Some number of LPs fall for it and believe it. Investors then spend time with LPs spinning amazing tales of “picking” and “proprietary deal flow” and “seeing something special in the Founder when no one else did…” and all kinds of other worthless lies which may have been closer to true in 1987 when there was limited capital and limited capital allocators but couldn’t be further from the truth in 2017 and the hyper efficient market that is Silicon Valley.

Yet enough people seem to buy it and it all seems to work with more and more dollars flooding the venture ecosystem and more and more people becoming practitioners of venture capital with no real training…until it doesn’t. And when it doesn’t, you need an investor who actually knows how to affect change, stand up for what’s right and do what’s right — on behalf of the Board, employees, executives and other investors. But these aren’t naturally occurring skills — these are hard fought, earned and practiced.

Unfortunately, by the time most investors are asked to use these skills — and they will because even the best startups don’t grow into giants without some turbulence along the way — so few investors actually have the skills to do so. You see, while they should have been learning the craft they’ve been too busy spending time purporting their fortune telling skills and trying to be loved so they can be on high flying boards and get some amount of fake credit along the way. That gets you on the Midas List. Giving hard advice sometimes makes enemies of the Founders and CEOs you aim to have love you long enough for the next list to appear. You see the incentive mismatch here.

So now, I’m really excited to see how @Forbes deals with the “credit” for Uber next year. Will Bill Gurley still get it or will he get demoted on the list? Will it now be given to Matt Cohler since he’s the new board member? Is this method consistently applied to other investors and other companies? What about the person who sourced Uber? How much credit should go to Peter Fenton? After all, he was “in the room where it (CEO resignation) happened” and played an integral role on behalf of Benchmark.

The point is that I doubt anyone at Benchmark cares. They just want to help Uber live out their potential. But the Midas List must go on! And when it does, a bunch of misguided looky-loos will make decisions or assessments based on it…

The sad reality is that nothing Forbes can do will be credible. Because teams help companies win. Individuals may be able to pick stocks but I don’t believe they can pick winners at a Series A in any predictable way. If you don’t believe me then see how much Series A investor overlap exists amongst the top 5 or 10 public tech companies (meagre) and how that has trended (worse). Teams source investments. Teams make those investments work. Teams transition board seats when new blood or new skills are necessary. Teams. Teams. Teams.

The faster we can dismantle the narrative fallacy and false celebration of investors “picking” winners in VC and ascribing too much credit to an individual, the faster we can build a group of investors with backbones, not constantly seeking individual fame and credit but working together as a team to help Founders and CEOs build companies and win. Not trying to be their best friend but telling them what they need especially in times when they may not want to hear it.

It’s not about staying on a board so you can get credit on a list. It’s about doing what’s right. Forbes you can help by moving away from individuals and creating a league table — like we have for EVERY OTHER PART OF THE CAPITAL STACK. Take away the incentives to compound lone wolf antics which really just end up with marginal governance and bad outcomes. Your Midas List data is pretty gerrymandered anyways so why not try something new. Besides, after this article, enough influential people in Silicon Valley will be embarrassed by this list and think its a joke anyways.

Rank firms instead.

We are happy to give you our audited returns to help kickstart things. Others should to. It would help the cause: we would have more honest conversations, accountability and better run partnerships which I think will lead to more honest conversations, accountability and better run startups so that they win more often and get to realize their products and ideas at scale.

And that is what we all want anyways…isn’t it?

One of the greatest experiences of my life was the opportunity to create and lead the Growth team at Facebook. Its success, at this point, is well understood and I’m not going to rehash it, but I do want to talk about what Growth means to me now, and where I think we need to go from here as an industry.

Growth, as I thought about it at that time, was a study of the complex and nuanced interactions between product, engineering, marketing and, in some cases, sales that drove demand. It was never meant to be anecdotal but always unapologetically empirical and quantitative. At its best, a smart effort around Growth puts companies into hyperdrive and enables them to raise the incremental capital they need to win. At its worst, Growth drives companies into the ground through the misallocation of resources led by misinformation. However, I’ve now come to realize that it’s time to broaden the definition and practice of Growth for both companies and investors alike.

Today, capital really isn’t an integral part of a company’s Growth equation and late stage fundraising decisions seem to be made with little regard to the nuances of a particular company’s path. In some instances, we see companies raise altogether too much capital. In others, they are surviving on fumes. In each case, I see capital being allocated to growing companies in a sloppy and haphazard manner. Did any operational rigor go into giving Company A $250M vs $50M for Company B? What if the right number for both A and B was $100M? While this frustrates me, it must be completely infuriating and unnerving to the entrepreneurs that feel the brunt of this sloppiness. The impact from either over or under capitalization are equally bad: board dysfunction, pressure to focus on short term objectives to justify the last round, bad or non-existent governance etc.

As far as I can tell, a large reason for this sloppiness in growth stage investing is that most Growth investors lack operational bona fides. While financially savvy, they rarely have the relevant work experiences that enable them to ask the right questions and thus properly allocate the right amount of capital and insights at the right time.

• What do we think about the company’s true demand?
• How will LTV/CAC change over time?
• What pitfalls and hidden costs come with market expansion — things I’ve seen firsthand before?
• How do I think about L12/L1?
• Can they really pull off that specific part of their technical roadmap?

From my perspective, we need to change how this part of the capital structure works on behalf of entrepreneurs. I suspect that answers to the kinds of questions above can help the growth stage investor act more beneficially when they allocate capital. But answering questions like those above is only possible when operators are involved. We need operators who can look at a Series C or D with the same framework and empathy as a Series A or B, with the experience and savvy of having done it before themselves, and the capital and the courage to then scale up the size of the investment.

I’m convinced this will improve the way growth investing happens. And the benefits will be obvious for a broad swath of companies when we have a product and operationally savvy investor class who can not only write $10–25M checks but $100M’s or even $B’s as well.

It is with this realization that I set out to find a Partner who I thought could build this new kind of Growth investing practice at Social Capital. And we found him in Tony Bates.

Tony’s resume and credentials are legendary: from managing many thousands of employees at Cisco to being CEO of Skype and President of GoPro, holding prior board memberships at YouTube, SiriusXM and currently serving on the boards of GoPro, Ebay and VMWare. But more important is his ability to bring the same product, technical and engineering mindset to big and small decisions alike. For entrepreneurs, that means that he will speak your language and then invest as much capital as you need to win.

Specifically, Tony’s role will be the CEO of Social Capital Growth and will be responsible for all private investments greater than $100M. This is a critical part of our strategy as we build the capability to be the full lifecycle partner to companies. Now, not only will we be able to lead great Series A and B investments through our Venture team but also continue to invest capital through their life as a private company via Tony’s Growth team and, eventually, be long term holders of their stock as a public company through our Public Equities team. Simply put, when Social Capital invests, we can be an investor in your company for decades. At the same time, each of our groups are empowered for scale and insights by our Platform. The Platform team brings both our companies and our internal teams the same power of machine learning, data science and data infrastructure to help our companies win that we did for Facebook — and much of it led by some of the original people from that team.

More details of our Growth investing efforts and our Platform will come out over time but in the meantime, I’m excited to know that a highly skilled product and engineering executive and operator is going to rewrite the rules of Growth investing on behalf of Social Capital and for the benefit of the entrepreneurs and companies who choose to work with us.

Changing the Growth Equation: Welcoming Tony Bates to Social Capital was originally published in Social Capital on Medium, where people are continuing the conversation by highlighting and responding to this story.

Over the last few years, I’ve been preoccupied with the established maxim, “venture capital doesn’t scale,” as it never quite made sense to me. It seemed the antiquated belief of an industry yet to be transformed, because we’ve seen firsthand how other markets can scale when empowered by technology and I suspect the venture industry is no different. Moreover, we could probably make a case that venture should be scaled so that we can take many more bets on all manner of ideas, from anyone around the world, thereby increasing the odds of the breakthroughs and progress that everyone ultimately wants.

For the few firms that have shared this belief, they’ve taken a legitimate yet traditional approach to scale. And to a traditionalist with thoughts of scaling, this has manifested by replicating the existing model at a different stage of capital (i.e. Seed, Growth, Public) or geography (i.e. India, China). But the real opportunity to scale venture capital isn’t just launching new products or relaunching the same products in new geographies.

To scale venture capital, you must build two important engines. The first is entirely technological. It’s software that empowers the fundamental process of decision making, capital allocation and risk management, which needs to evolve to support investing at scale, at high velocity yet at repeatedly high rates of return. This is an incredibly difficult problem that software and a platform-oriented mindset are purpose built to solve. I’m excited to say that we’ve started to do just this, but more on that over time.

At the same time, software is just one piece. The second engine is one of deals, relationships and a mindset that I summarize as “being open for business”. What this means is the strategic capability, insight and wherewithal to work with all kinds of organizations all over the world. Governments who want to transform their economies, balance sheets needing to invest hundreds of billions of dollars and companies who need a partner to help navigate all of the technological disruption they may or may not see. Each of these entities have repeatedly tried to engage with us in a scaled way, and frankly struggled, until now.

It is with great honor that we announce that Marc Mezvinsky has joined Social Capital as Vice Chairman. Marc will be responsible for building our engine to partner with these organizations, in a scaled way, on a global basis. He brings the right skill set to this critical task. Along with graduating from both Stanford and Oxford, he spent many years at Goldman Sachs before joining 3G as a Partner — all the while learning about global finance from two of the premier organizations in the field. After his time at 3G, Marc most recently ran a large macro hedge fund.

More importantly, Marc and I have been friends for over a decade and I have seen firsthand his ability to think strategically and engage equally well with both CEOs and engineers. He has a common touch which is rare for someone with such deep experiences and relationships in politics, finance and philanthropy.

I’m thrilled Marc is joining us in building a new kind of company as we pursue our mission to solve the world’s hardest problems. He will be based in NYC where he lives with his wife and two kids.

VENTURE CAPITAL DOESN’T SCALE…UNTIL IT DOES was originally published in Social Capital on Medium, where people are continuing the conversation by highlighting and responding to this story.

There has been a lot of talk recently about why LinkedIn sold to Microsoft. One of the more popular theories about why they sold was around LinkedIn’s use of Stock Based Compensation (SBC) — as advanced succintly here by Andrew Ross Sorkin.

This isn’t the first time that people have started to question SBC — but not for the reasons you may think. SBC isn’t bad. In fact, it is really good and a powerful tool to motivate and reward management and employees. The bigger issue has been related to how it is accounted for under GAAP (Generally Accepted Accounting Principles) and how some tech companies, specifically, have taken advantage of a lenient interpretation, therein, to potentially mask their true performance.

Why is this important? It’s important because Silicon Valley seems to always be under a microscope — of bubbles, of funding, of unicorns, etc. But more generally, these are all ways for the rest of the world to constantly ask themselves, and us, if we deserve to have credibility and be on the world stage. SBC is working hard to be a candidate for the next test.

When our ability to build profitable, standalone companies in a transparent way is questioned, it can create a long term trend of tepid funding, marginal liquidity and mistrust by markets. That serves none of us (founders, employees, investors) well so we should understand why this is becoming a bigger issue and also understand some things we can do to measure and think through the implications of our decisions.

Need more motivation? Warren Buffett had something very pointed and direct words to say on this topic in Berkshire’s annual letter this year and the entire issue was summarized well here.

Let’s begin…

Building companies is hard. It takes a lot of luck and impeccable timing. But none of that matters unless you also have great people. Great people usually join companies because of the scope and freedom of their work, the quality of the people they get to work with and the impact of the product they are building. But they also join because, no matter how mission driven people are, they expect to be rewarded (richly, so) through stock options or its cousin, the RSU.

In 2008 (or thereabouts) after Facebook raised money from Microsoft, we had to come to terms with the fact that stock options became less enticing to prospective employees. Why? Despite the fact that options can result in long term capital gains (ie more value via less taxes), the strike price of the options became so high as to make the likelihood of any meaningful outcome less certain in the eyes of potential employees.

In response to this, we used RSUs (Restricted Stock Units) that behaved like a combination of stock and cash. The RSUs could track the value of the company’s increasing value (like a stock option) but there would be a baseline amount of guaranteed value.

Sidebar: Options vs RSUs

As you can see above, the RSU is equivalent to giving someone cash (ie a guaranteed payment in all cases) while an option gives someone exposure to upside but no guaranteed payout at all. As you can imagine, this can impact and create huge distortions in the behavior of those who hold options vs RSUs.

Why?

Options incentivize both employees and management to set high hurdles and beat them — only rewarding value creation above the point at which the option was issued — because otherwise the option is worthless. This is clearly different from RSUs, which inevitably incentivize the status quo and a focus on vesting since the payment is guaranteed.

Consider the payoff graph below which illustrates this point:

Said in yet another way, options push management and employees to achieve OKRs that would likely push stock prices up. If the OKRs are not achieved, the grant would not dilute existing shareholders and the options would be worthless. In the case of RSUs, the dilution is certain regardless of OKRs being met or not or whether the stock price goes up or not.

Now that the differences between an option and an RSU are clear, what if I told you that GAAP had strict accounting for options but a loose accounting for RSUs?

How to account for legitimate expenses? The RSU/SBC quandary…

So now ask yourself the following question: if you are an investor who wants to invest and support a company or a prospective employee about to join a company, and you are shown a P&L so you can make your decision about the economic health of that company, would you expect that RSUs are treated equivalent to someone’s salary and are treated as a legitimate expense in the primary P&L used or only reported as part of a separate P&L? Again, Buffett and Sorkin (and many others) think it should be part of a company’s primary P&L.

Until now, stock-based compensation hasn’t received much criticism, and the practice of unicorns and certain public companies issuing RSUs in place of options (and inheriting a squishy way of accounting for them) has been generally accepted. But that’s starting to change, since most reporting around SBC has been far from straightforward and the frustration has grown to an almost fever pitch amongst sophisticated investors. It’s interesting to note that during all of this, the companies driving this change are industry stalwarts Facebook and Amazon.

Why are Facebook and Amazon including SBC in GAAP financials?

I suspect it is because they realize that not only are they using SBC as a way to spend richly on management and employee compensation, but that it is justified because it ends up driving massive shareholder value far in excess of the cost.

Moreover, while its true for the likes of Facebook and Amazon, they’ve likely measured and seen that it isn’t true for some/many of their competitors or acquisition targets. And by potentially influencing others to report SBC as a primary GAAP metric, I suspect these companies start to look even better — to shareholders and prospective employees.

And this likely matters since it will allow them to have even more shareholder support as they continue to aggressively spend on the future by innovating in far flung ideas or inorganically grow through M&A.

The other side of the coin is equally true. If a company spends richly on SBC, then there will be an expectation that somehow, somewhere in the near future, performance of the company will show that those costs and dilution were worth it.

So putting ourselves in the shoes of Facebook and Amazon’s CFOs, we built a few simple charts that I suspect they already looked at and are handy ways for anyone interested in this to do the same. And while I’ve highlighted Facebook as a positive example of how to use SBC below, you can see in these graphs why Sorkin came to the conclusion he did with respect to SBC potentially driving LinkedIn’s decision to sell.

Take a look…

What this means is that Facebook spends 15% of every dollar in revenues on SBC.

What this means is that Facebook spends 27% of every dollar of profits on paying their management and employees.

And all of these RSUs end up diluting existing Facebook shareholders by 5.5% every year (ie if you owned 1% this year, you would own 0.945% next year). Note that Apple is negative because they are net buyers of their own stock.

But it’s clearly worth it since the market cap of Facebook went up $44.66 for every $1 of SBC.

What happens, then, if SBC continues to grow at a company? Again, it depends on what the company does. If the company is working on a compelling strategy, innovating on new products and generally crushing it, the stock will go up and everyone will be happy.

But if, on the other hand, earnings flatten then multiples will contract and the stock will go sideways or down which can have a material impact to morale and ability to recruit.

Conclusion

At some point, if you are lucky enough to be a part of founding or working at a viable company, understanding options vs RSUs and how to account for SBC will be as important as how you should think about comp, long term business model, profitability and earnings. SBC gone awry can destroy your expectations of long term value creation as a stockholder. SBC used in smart ways can be a force multiplier on value creation.

In all cases, however, we should probably start preparing for a world where SBC becomes a standard part of how we all measure ourselves…

Spending Money to Make Money…aka Stock-based Compensation…aka Listen up, Founders! was originally published in Social Capital on Medium, where people are continuing the conversation by highlighting and responding to this story.

Here at Social Capital we’ve been watching Tesla for many years. We originally tried to get cute on valuation and almost had our faces ripped off. We’ve learned that changing your mind is free — so we did and have been happy supporters ever since. We’re consistently amazed at Elon’s ability to stay true to an ambitious and audacious vision despite the naysayers.

The naysayers came out this past week calling into doubt the pre-order figures that Tesla has been releasing. They cited anecdotes of individual buyers who have managed to get 20 reservations — well above the two reservations per order limit — and suggested a speculative bubble. To get to the bottom of this, we went to our friends at Second Measure to get a read on how the pre-order sales actually went. For those unfamiliar, Second Measure has a panel of several million US credit and debit cards and subsequently provides remarkably deep analytics on spending behavior across a very large subset of US households.

The Second Measure data was irrefutable. It indicated to us that of all pre-ordering customers, 96% reserved only a single car. A further 3.5% reserved two cars and <0.5% made 3 or more. Put another way, the pre-order figures that Tesla is releasing could only overstate unique customers by no more than ~4%, and the true speculative bubble, if any, was limited to less than 0.5% of the buying population. If we had instead seen a significant fraction of customers going above and beyond the two-car limit that would have been a sign of a possible speculative bubble, as it would have suggested a very large fraction of the reservations were going to individuals who were reserving multiple cars presumably for speculative purposes rather than actually using them. However, at less than 0.5%, we remain very bullish that the Model 3 pre-sales figures represent true broad based demand.

To help put this into perspective, 400,000 pre-orders at $40,000 suggests demand at the level of $16B in sales. By our estimates, it took the iPhone roughly 2 years from their launch in Q3 2007 to reach $16B in cumulative worldwide sales (27M units at $600 each). While one may not have been convinced in Q3 2007 that it was a generation defining event in technology, one would certainly have seen it as undeniable by Q3 2009 that the impact was truly enormous.

The more time we spend, the more it seems to us that when looked through the lens of Model 3 demand, the quality of the product and the laggard nature of their competitors, Tesla’s iPhone moment may have arrived.

In thinking through the broad impacts of technology, we increasingly find ourselves investing in public markets as well. I don’t view these as distinct efforts — I view them as a broad reflection of our world view on change, opportunity and leadership. In fact, many of our private companies drive a better understanding of many public companies (and vice versa).

All of this preamble brings me to TSLA.

Three or so years ago, I made a massive miscalculation about TSLA and didn’t quite understand what it was all about. If you listened to the peanut gallery, you would have thought it was a car company and should be valued as a car company. We (or, really, I) fell for this. And after much reflection, we (erroneously) shorted it around $50/sh. It then ceremoniously ripped in our face to $100 and right before we capitulated and covered, it went down briefly enough where we could cover some of our losses and get out somewhat, but not entirely, unscathed. It was a great lesson that confirmed for me several things:

. Never stand in the way of a revolutionary, visionary Founder

. Do not stop at the first layer of detail — you must confront your biases and ask the more nuanced questions

. Believe in the future and the cycles of technology that will converge markets faster that you may think — making competitors out of disparate entities faster than you can imagine

So what is the future of TSLA?

In the intervening few years, we’ve spent a lot of time thinking about cars, software, autonomous vehicles, the future of asset ownership etc. and at the intersection of all of this, is our current view of TSLA. In our opinion, TSLA is the birth of the first HaaS company at scale. What is hardware-as-a-service? It is the realization that thru efficient assembly, modern technology and massive amounts of software, the economics will make it more obvious for a consumer to subscribe to an asset, like a car, than own a car.

Autopilot was the coup de grace for me on this HaaS line of thinking. With 100k’s of cars collecting millions of data points likely every hour(!), their software will become iteratively better, bordering on amazing, over time. At this point, it will be up to TSLA to simply decide that instead of selling a consumer a car, they can allow that consumer to subscribe to a car — or really, a massive fleet of cars.

Now imagine those fleets of TSLAs roaming the streets autonomously waiting for you to use your app and hail the closest car. While TSLA may still make the cars, their real value will be in elegantly managing the subscription, having the best software and the predictability of their service (same cars, same smell, same music playing when you immediately get in etc.).

It seems obvious to me that with the push around autonomy, it just won’t be TSLA driving to this future. BMW, Mercedes-Benz, Toyota and any other car company who wants to survive will need to become a software company first and view the building of the car as no different than Apple viewing the latest iPhone: as a physical case for iOS. These physical cases for iOS can, must and will change but make no mistake — the value is in iOS — no matter how much marketing is spent to convince you that you are buying the next great improvement to their screen or camera or some-such.

In a few years, I expect that GOOG, AAPL and TSLA will each have massive autonomous fleets on the road. You will be able to pay with you Apple Pay account, auth with Gmail, etc.

I suspect at this point, it will only take one ambitious city manager who wants to run for mayor to realize that fleets of autonomous cars are the solution to a non-trivial percentage of transportation for their citizenry. And then every other ambitious city manager will follow suit and we will transform how cities transport their inhabitants forever.

In this world, I’m most hopeful and confident in TSLA. I know pretty conclusively that if TSLA offered me a subscription service to their fleet of cars, I’d sign up in a heartbeat. And for every ounce of enthusiasm for TSLA, I’m also conceptually short, in equal measure, the auto industry who doesn’t understand this move to software and HaaS. Separately, I think Insurance as we know it changes fundamentally…probably for new entrants or consolidation amongst a few at lower economics and value (remember that the entire auto insurance market is predicated on the calculations and errors of humans).

Lastly, the landscape becomes even more interesting when you factor in the plans of Uber, Ola, Didi etc. It’s not clear to me how any of that plays out — when the competitive set is TSLA v. GOOG v.AAPL v. BMW v. MB v. Uber v. Ola v. Didi etc., but I suspect that we, as consumers, will definitely be a predictable long-term winner.