20VC eShares' Henry Ward on Why Portfolio Theory Is Wrong Why Investors Will Never Take Market Risk & Why You have To Have A Line of Sight To A $Bn Outcome

In this episode of "20 Minutes VC," host Harry Stebbings interviews Henry Ward, CEO and founder of eShares, a comprehensive cap table management platform. They discuss the challenges and successes of eShares' fundraising journey, with insights into the skepticism of early investors, the importance of market size, and the pursuit of gradual, stepwise growth over chasing large markets. Henry emphasizes the alignment of interests between private companies and their investors, contrasting it with the public market's disconnect. They also explore the future of startup financing, advocating for a regulatory framework that fosters pre-IPO liquidity and reduces entrepreneurs' cost of capital. Additionally, Henry shares his vision for enduring companies to remain privately held, finding liquidity in private markets rather than going public. The conversation includes contributions from past guests and investors such as Manu Kumar and Semil Shah and touches on the broader trends and mentality in Silicon Valley's investment landscape.

• Henry Ward is the founder and CEO of eShares, a cap table management platform.
• eShares provides equity management, 409A valuations, and liquidity services.
• The company is backed by notable investors such as Union Square Ventures, SV Angel, Spark Capital, and others.
• Henry previously founded Secondsight, a fintech company that did not survive its seed round.
• The idea for eShares came from a lunch conversation with investor Manu Kumar, who highlighted a problem with stock certificate management.

"And I was an entrepreneur without an idea. And Manu and I were having lunch one day and he said, you know, I have this problem, this stock certificate problem. I would love for a company to exist to solve it. If you'll start the company, I'll invest in it."

This quote explains the origin of eShares, stemming from a real-world problem identified by an investor, which led to the creation of the company with the promise of initial investment.

• Raising the seed round for eShares was exceptionally difficult.
• Investors were concerned about the market size and whether Series A investors would find the idea appealing.
• The startup environment in 2012-2013 was focused on more trendy opportunities like new databases and photo-sharing apps.
• There was skepticism among angel investors regarding why no one had previously addressed the stock certificate problem eShares aimed to solve.

"The seed round especially was very hard. I think all seed rounds are hard, but this was, I think, exceptionally hard."

The quote emphasizes the difficulty of securing a seed round for eShares, highlighting it as a particularly challenging task compared to typical seed funding efforts.

• There was a perceived market size question by investors during eShares' early fundraising.
• Investors were looking for ideas that would appeal to Series A investors, focusing on large, exciting markets.
• eShares did not fit the popular investment trends of the time, making it harder to raise funds.
• The obviousness of the eShares solution paradoxically led to investor distrust, as they wondered why the solution did not already exist.

"And so there was a lot of risk around market risk. And then somewhat paradoxically, most of the angel investors that I talked to, the number one question I got was, why hasn't anybody done this?"

The quote reflects the concerns of angel investors and the difficulty in convincing them of the viability of eShares due to the lack of existing solutions in the market.

• Henry Ward suggests that there is a culture of over-ambition among startups, with founders aiming for huge markets (trillion-dollar TAM) instead of addressing valuable, unsolved problems.
• Startups often focus on reaching the summit (scaling El Capitan) rather than finding a way to get on the wall.
• An investor during eShares' Series A fundraising expressed that while he found eShares valuable, he needed larger market opportunities.

"I often call startups scaling El Capitan, but everybody's looking at how do I get to the top as opposed to how do I get on the wall?"

This quote metaphorically compares startups to climbing a mountain, criticizing the focus on reaching the peak instead of the initial steps needed to start the climb, reflecting on the ambitious nature of startups and investor expectations.## Investment Criticism and Business Visibility

• Investors often seek clear visibility to a large outcome when evaluating businesses.
• eshares faced criticism for lacking a clear line of sight to a significant financial outcome.
• The company's strategy involves climbing the wall and finding new ledges, implying gradual progress without a clear end in sight.

"And that's been true for us for the beginning, is that investor criticism of eshares is there isn't line of sight to a big outcome." "This is very much a we get onto each new ledge as we climb the wall and just have faith that at each new ledge we'll find another ledge."

• The first quote highlights the criticism from investors regarding eshares' unclear path to a significant financial outcome.
• The second quote describes eshares' approach to growth as incremental, akin to climbing a wall and discovering new opportunities at each stage.

• Investors may be wary of businesses that are built in layers due to the dependencies between steps.
• Henry Ward acknowledges the legitimacy of investor concerns about risk, especially market risk which they cannot control.
• eshares prefers a stepwise approach to growth, starting with small markets and expanding concentrically.

"I had another investor in my seed round who I like a lot, who's now a huge advocate for eshares, but he had said to me, I don't like businesses that require steps because there's dependencies."

• This quote reveals an initial investor concern about the stepwise nature of eshares' business model, highlighting the perceived risk associated with dependency on sequential achievements.

• Venture capitalists typically avoid market risk but are willing to take on execution and team risk.
• eshares believes in winning small markets first and then growing to build monopolies.
• Henry Ward challenges the high failure rate in venture capital and suggests a strategy of consistent smaller wins rather than only seeking home runs.

"But when you look at execution risk, if there's multiple dependencies that have to happen for you to get to the outcome that the investor is looking for, all that does is introduce risk."

• This quote explains the investor perspective on layered business models, where multiple dependent steps introduce additional risk to achieving the desired outcome.

• Henry Ward acknowledges the power law in venture capital but believes more 'best outcomes' can be created through a stepwise approach.
• He cites Facebook's initial success in monopolizing the Harvard campus as an example of starting with a small market and expanding.
• The current venture strategy often focuses on rapid access to huge markets, which aligns with a home run mentality.

"I do think that you can create more best outcomes by looking for companies that have a more stepwise function into a large outcome that start with small markets and grow."

• The quote suggests that a gradual approach to scaling a business, beginning with dominance in smaller markets, can lead to more successful outcomes than the typical venture capital strategy of seeking immediate large markets.

• There is a herd mentality in venture capital, with investors looking up the chain to see what others are investing in.
• This mentality can create opportunities for original thinkers to invest in innovative ideas.
• Manu is mentioned as a VC who exemplifies this original thinking approach.

"I think a lot of venture is momentum investing and so they're looking at what everybody else is looking at."

• The quote describes the trend-following nature of venture capital, where investors often make decisions based on the actions of their peers rather than independent analysis.

• The increasing time to IPO is creating pressure for liquidity in the market.
• Companies are adjusting employee vesting schedules in response to the longer time required to build a company to the scale desired by investors.
• This trend is seen as a structural shift, not a temporary one.

"I think it's a problem in the sense that it's creating a pressure for liquidity that currently isn't being serviced."

• This quote highlights the issue of delayed IPOs leading to a demand for liquidity solutions in the market, which is not currently being met effectively.## Liquidity Challenges in Capital Markets

• There is a stark contrast in liquidity between public and private markets, with hyper liquidity in public and almost none in private.

• The absence of intermediate liquidity solutions for private companies is a significant structural issue in capital markets.

"I think one of the big problems structurally in the capital markets world today is we have an environment of hyper liquidity in the public universe, and then zero liquidity in the private, and there's literally nothing in between right now."

The quote highlights the imbalance of liquidity options available to companies, emphasizing the need for solutions that provide liquidity to private companies without requiring them to go public.

• Eric Ries is proposing an alternative to traditional public markets with the LTSE (Long-Term Stock Exchange).
• LTSE aims to provide a different set of governance rules for companies that go public.
• There is a principal-agent problem in public markets where CEOs, not investors, decide where to go public, affecting corporate governance.

"My understanding of the LTSC is they're going to compete with public market exchanges. So they're not sort of providing an alternative for private companies. They're providing an alternative for private companies that go public to trade on an alternate exchange."

This quote explains that LTSE is not a solution for companies to remain private but rather an alternative exchange for those that decide to go public, with different governance rules.

• Private companies tend to have better alignment between management and investors compared to public companies.
• This alignment is a reason why private companies may prefer to stay private.
• Innovation in private companies is partly due to this better alignment.
• Public market models struggle with balancing the interests of companies and shareholders.

"I think one of the reasons that private companies work well and are working better and better, is that the alignment of management and investors is more highly aligned in the private world than they are in the public world."

The quote emphasizes the closer alignment of interests between management and investors in private companies, which contributes to their effectiveness and innovation.

• Regulation is not inherently bad and can be beneficial if applied correctly.
• Lack of regulation and liquidity in startup financing leads to higher costs of capital.
• Regulation in public markets is a patchwork designed to prevent fraud, which could be improved.
• The private market has the opportunity to create a new regulatory framework from scratch.

"What I think is interesting about the private world is we have an opportunity to rebuild regulation from scratch."

This quote suggests that the private market offers a unique chance to design a new and more effective regulatory framework that could benefit all parties involved.

• A progressive approach to pre-IPO liquidity could dramatically reduce the cost of capital and increase capital freedom in private markets.
• Difficulty in investing or exiting private company investments contributes to high costs for entrepreneurs.
• Introducing a framework for regulation and liquidity could resolve many capital-raising issues for private companies.

"I would love to see a more progressive view on pre IPO liquidity or private market liquidity, because I think if the ecosystem says that there's opportunities for liquidity without going public, I think the cost of capital and the freedom of capital expands dramatically in the private world."

The quote expresses a desire for a shift in how private market liquidity is viewed and managed, suggesting that such changes could significantly benefit the ecosystem by lowering costs and increasing the flow of capital.## Alternative Investment Strategies

• The market is evolving with new investment strategies beyond traditional IPOs.
• Investors and entrepreneurs are considering different avenues for growth and success.
• A diversified approach to investment may strengthen the private market.

"There's more alternatives than just, I want to be the moonshot company that gets the IPO."

This quote highlights the shift in perspective among investors and entrepreneurs, acknowledging that there are multiple pathways to success beyond the traditional IPO route.

• Increased liquidity is seen as beneficial for fostering grassroots initiatives.
• Additional capital flow can stimulate further investment and entrepreneurial activities.

"And the increased liquidity, I think, will kind of help foster further grassroots initiatives with the additional capital going in."

Henry Ward indicates that liquidity can spur growth at the grassroots level, implying that easier access to capital can lead to increased innovation and business ventures.

• The book is a compilation of Warren Buffett's writings, offering insights into financial structures and corporate governance.
• It is considered an essential resource for understanding how to build a company culture and improve writing skills.
• The book is mandatory reading for executives at Henry's company.

"My favorite business book is the essays of Warren Buffett, and it's just a collection of everything he's written from annual reports and investor letters."

Henry Ward emphasizes the comprehensive nature of the book, which compiles Warren Buffett's wisdom and is used as a learning tool within his company.

• Rapid company growth can lead to shifts in employee alignment.
• Leaders must continuously ensure that employees understand their role in the company's mission.
• Growth necessitates constant communication about the company's objectives and employee alignment.

"The hardest thing that I've been dealing with lately, we've grown from, in 24 months, we've grown from 20 people to 120 people."

Henry Ward shares the challenges associated with managing a rapidly expanding team, highlighting the need for maintaining alignment with the company's mission.

• A five-year vesting schedule is used to encourage long-term commitment from employees.
• The exercise period for stock options is matched to the vesting period to align incentives.
• Equity compensation is viewed as a key factor in talent retention, especially in Silicon Valley.

"I think more and more we'll start seeing companies aligning equity incentives to a much longer timeframe and a more valuable timeframe for companies."

Henry Ward discusses the strategic use of stock options to align employee interests with the company's long-term success.

• Henry keeps an eye on Hacker News and reads content from Andreessen Horowitz.
• CEO-written content is particularly valuable for gaining insights and knowledge.
• There is no definitive guide for being a CEO; learning from peers is crucial.

"The best way to learn is from other ceos, and that's been super helpful."

Henry Ward expresses the importance of learning from other CEOs' experiences, which he finds more valuable than traditional books on leadership.

• Eshares aims to address liquidity problems in the market.
• The company challenges the dichotomy between public and private markets.
• The vision for the future includes great companies remaining privately held and finding liquidity outside of public markets.

"Our vision for the world is that the great enduring companies will actually be privately held and they will find liquidity in private markets rather than public markets."

Henry Ward outlines the long-term goals for Eshares, which include innovating in the private market space and offering alternatives to traditional public market liquidity.

• Henry thanks those who facilitated his appearance on the show.
• There is a sense of excitement about the future of Eshares.
• The host promotes personal goals and productivity tools, suggesting a focus on self-improvement and efficiency.

"Some very exciting times ahead for eshares, and a huge hand to manu at canine and Nav at realty shares for the intro, without which the show would not have been possible."

Harry Stebbings closes the conversation by acknowledging the contributions of others to the show and expressing optimism about the future of Eshares.