Season 2, Episode 5 The Dropbox IPO

Summary Notes


In episode two of season five of Acquired, hosts Ben Gilbert and David Rosenthal discuss the IPO of Dropbox, a company that revolutionized file syncing and sharing. They delve into Dropbox's journey from a Y Combinator startup to a publicly-traded company, highlighting its viral growth, freemium model, and the decision to move off AWS to cut costs. Despite facing challenges with product expansion and maintaining focus, Dropbox managed to retain a significant portion of founder equity, with Drew Houston owning 25% at IPO. The episode also touches on the evolving landscape of small businesses and the potential market for Dropbox's core product, as well as the skepticism surrounding its ambitious mission to "unleash the world's creative energy by designing a more enlightened way of working."

Summary Notes

Dropbox's Valuation and Funding

  • Dropbox raised $350 million at a $10 billion post-money valuation.
  • They sold only 3% of the company during this funding round.
  • The valuation and funding are indicative of the company's perceived high value and growth potential.

"It's roughly the same. And then they raised 350 at a $10 billion post money. So they sold 3% of the company. That's crazy."

This quote highlights the impressive fundraising achievement of Dropbox, securing a large sum of money while giving up a relatively small percentage of the company, reflecting investor confidence and a high valuation.

Acquired Podcast Episode Introduction

  • Ben Gilbert and David Rosenthal host the podcast Acquired.
  • The episode discusses Dropbox's IPO and its significance in the tech industry.
  • The hosts speculate on whether Dropbox's IPO will lead to more tech companies going public.

"Welcome to episode two, season five of acquired, the podcast about technology, acquisitions and ipos. I'm Ben Gilbert. I'm David Rosenthal and we are your hosts."

The quote introduces the hosts and the podcast, setting the stage for the episode's focus on Dropbox's IPO.

Dropbox IPO and the Tech Industry

  • The IPO of Dropbox is considered a significant event in San Francisco and the tech industry.
  • The hosts discuss the potential for a trend of tech "unicorns" going public following Dropbox's IPO.
  • They ponder whether this will be a stampede or a slow procession of IPOs.

"It was a big day here in San Francisco yesterday."

This quote captures the local excitement around Dropbox's IPO, suggesting its importance to the tech community in San Francisco.

Acquired Podcast's Approach to Episodes

  • The hosts prefer to analyze acquisitions and IPOs after some time has passed.
  • They aim to evaluate the success and impact of these business decisions.
  • The episode about Dropbox's IPO is an exception due to the compelling story and current interest.

"Listeners, as you know, on the show, we generally like to do most of our episodes taking a good amount of time since either the acquisition or the ipo happens."

The quote explains the usual approach of the podcast, which involves detailed analysis after the fact, but makes an exception for Dropbox due to its intriguing narrative.

Listener Engagement and Support

  • The podcast encourages listener participation through Slack and email updates.
  • Listeners are invited to contribute by reviewing the podcast on Apple Podcasts.
  • Positive reviews help increase the show's visibility and attract new listeners.

"So if you're new to the show, you can check out our slack at acquired FM. It's easy to either join the slack there or get email updates about when we have new episodes."

This quote is an invitation for listeners to engage with the podcast community, indicating the hosts' desire for listener involvement.

Sponsorship and Pilot Partnership

  • Pilot is a sponsor and partner of the Acquired podcast.
  • Pilot provides accounting, tax, and bookkeeping services for startups and growth companies.
  • The company has grown significantly and is now backed by major investors such as Sequoia and Jeff Bezos.

"Our next sponsor for this episode is one of our favorite companies and longtime acquired partner pilot for startups and growth companies of all kinds."

The quote introduces Pilot as a sponsor, emphasizing the podcast's relationship with the company and its relevance to the startup community.

Outsourcing Non-Core Business Functions

  • Jeff Bezos's axiom about focusing on core business strengths is discussed.
  • Accounting is highlighted as a critical function that should be outsourced if it does not contribute directly to product or customer experience.
  • Pilot is recommended for handling financial operations, allowing companies to concentrate on their core competencies.

"And speaking of Bezos, we talk all the time on acquired of Jeff's AWS inspired axiom that startups should focus on what makes their beer taste better."

This quote references Jeff Bezos's advice for startups to outsource non-core activities, using Pilot as an example of a service that can handle such functions efficiently.

Dropbox Founding and Y Combinator

  • Drew Houston and Arash Ferdowsi founded Dropbox after participating in Y Combinator.
  • Y Combinator played a significant role in Dropbox's early development.
  • The history of Y Combinator itself is intertwined with the story of Dropbox.

"All right. Well, to really, truly do justice to the history of Dropbox, you kind of also have to talk about the history of another organization that sort of, surprisingly, we haven't talked that much yet about on this show, but it's pretty important."

The quote emphasizes the importance of Y Combinator in the history of Dropbox, suggesting that the two are closely linked in their development.

The Origins of Y Combinator

  • Y Combinator was founded in 2005 by Paul Graham, Jessica Livingston, Trevor Blackwell, and Robert Morris.
  • The initial concept was to run a summer program for college students to start companies.
  • Y Combinator began with a fund of $200,000 and evolved from a summer founders program to a year-round startup incubator.

"So back in the really early days, I think a lot of people know about Paul Graham, who is one of the founders of Y Combinator."

This quote introduces Paul Graham and the early days of Y Combinator, setting the stage for its influence on startups like Dropbox.

Drew Houston's Path to Founding Dropbox

  • Drew Houston was inspired by his fraternity brother Adam Smith's success with Zobni and Y Combinator.
  • Houston had previously applied to Y Combinator with a SAT prep company but was rejected.
  • The idea for Dropbox came when Houston forgot his thumb drive and began coding a Filesync solution on a bus trip.

"He's super inspired. He sees Adam's kind of path through YC, says he has to do it, too."

The quote captures Drew Houston's motivation to start a company and apply to Y Combinator, influenced by the success of someone in his network.

Dropbox's Early Development and YC Application

  • Drew Houston met Arash Ferdowsi through a mutual acquaintance and they quickly decided to co-found Dropbox.
  • They created an explainer video for Dropbox that showcased the core functionality of the product.
  • The simplicity and clarity of Dropbox's Y Combinator application are highlighted as exemplary.

"So he applies to the summer now, summer 2007 application cycle for Y combinator. He submits his application."

This quote describes Drew Houston's application to Y Combinator with Dropbox, marking the beginning of a pivotal chapter in the company's history.

Dropbox's Core Product and Distribution Strategy

  • Dropbox's core product has remained largely unchanged since its inception.
  • The product's key features include file synchronization, visual indicators for syncing status, and low-level operating system integration.
  • The company utilized popular culture memes in their promotional video to aid in virality.
  • The video was posted on Hacker News, Reddit, and Digg, which helped Dropbox acquire its first users.
  • The simplicity and clarity of the product led to a strong understanding and desire among potential users.

"all the low level operating system hooks, it's all done. I mean, basically, very little has changed." "So they make this video, and then they really also, this is the other core of the product." "The video goes viral and then that's how they get their list for their first users."

The quotes underscore the fundamental aspects of Dropbox's product that have remained constant over time and the innovative marketing strategies that helped it gain initial traction.

Criticism and Skepticism

  • Early criticism of Dropbox focused on its perceived limitations for Linux users and the feasibility of its business model.
  • Critics doubted the product's ability to replace USB drives and generate income.
  • A Hacker News user's skepticism about Dropbox's potential was countered by Drew Houston, which led to a positive resolution.

"I have a few qualms with this app and the first one is about being a Linux user." "It doesn't actually replace a USB drive." "It does not seem very viral or income generating."

These quotes reflect the initial doubts about Dropbox's utility and business prospects, demonstrating the challenges faced by new technologies in gaining acceptance.

Dropbox's Founding and Early Success

  • Dropbox was founded with a clear vision and product that immediately met a market need.
  • The founders utilized Y Combinator's network to promote and grow their user base.
  • Initial funding rounds were strategically executed, leading to significant investments with minimal dilution.

"They just nailed it so hard out of the gate." "So then Ben, what you were referring to when they post this on hacker news?" "So they get accepted into YC. Everybody's excited."

These quotes emphasize Dropbox's early product-market fit, the strategic use of networks like Y Combinator, and the successful fundraising efforts.

Competition and Market Positioning

  • Dropbox faced competition from similar services and the looming threat of Google's rumored G Drive.
  • Despite the competition, Dropbox's user experience remained superior.
  • The company's simplicity and reliability were key differentiators.

"There's mosy, there's carbonite, there's, I don't sugar sync." "Sure feels like this is something the platforms should provide." "Dropbox just nailed the crap out of the user experience."

The quotes highlight the competitive landscape Dropbox operated in and the company's focus on user experience as a competitive advantage.

Investment and Growth

  • Sequoia Capital's investment played a crucial role in Dropbox's growth.
  • The relationship between Sequoia and Y Combinator was strengthened through investments in Dropbox.
  • The company's lean approach and cash flow positivity were notable during its growth phase.

"Samir and Sequoia do a $1.2 million seed round in the company as convertible debt." "So that was in the fall of 2007." "Last year, Dropbox made 300 million in free cash flow."

These quotes discuss the details of Sequoia Capital's involvement with Dropbox and the company's financial health, illustrating the impact of strategic investments.

Viral Distribution and Freemium Model

  • Dropbox's referral program was a key component of its viral distribution strategy.
  • The company's freemium model allowed it to convert a small percentage of a large user base into paying customers.
  • Dropbox's approach to collaboration and sharing facilitated its viral growth.

"So it naturally virally spreads the product, but they also put in place this kind of gamified incentive to do so." "I was a referral maniac to get more space." "The small percentage who do just the number of users are so big, they make so much money."

The quotes capture the essence of Dropbox's viral marketing strategy and the effectiveness of its freemium business model in monetizing a large user base.

Strategic Mistakes and Realignment

  • Dropbox made strategic errors by venturing into non-core areas such as photo sharing and email clients.
  • The company faced challenges in defining a clear business strategy during its expansion.
  • Dropbox eventually refocused on its strengths, leading to a successful IPO.

"I know we should go into photo sharing and we should be highly acquisitive and go into email clients and we're definitely email clients." "But none of it makes any sense, none of it works."

These quotes reflect the strategic missteps Dropbox encountered as it expanded beyond its core competencies and the subsequent need to realign its focus.

Key Theme: Dropbox's Departure from Core Strengths

  • Dropbox initially excelled by solving a common problem with a simple solution.
  • The period of 2013 to 2016 saw Dropbox moving away from its strengths.
  • New features and products during that time were complex and not necessarily solving real problems.
  • This complexity led to a loss of the simplicity and reliability that were hallmarks of Dropbox's success.

"And I think it's to pull forward a tech theme here, as we so often do on this show. I think it's that they just kind of lost sight of what it was that was so brilliant about Dropbox in the first place, which was two things. One, they solved a real problem that a lot of people had, and two, they made it just work."

This quote by Drew Houston emphasizes that Dropbox's brilliance was in its simplicity and effectiveness at solving a real problem. The period of deviation from these core principles led to complications in the product.

"It was the opposite of the initial YC application. Really?"

Ben Gilbert's response reaffirms the sentiment that Dropbox's newer direction was a stark contrast to its original simplicity and purpose.

Key Theme: Strategic Reorientation and Lean Operations

  • Dropbox underwent a strategic shift in 2016, reminiscent of Intel's pivot from memory to CPU business.
  • The company refocused on its core customer base and eliminated non-essential products and services.
  • Hiring Dennis Woodside as COO was part of the turnaround strategy to streamline operations.
  • Dropbox transitioned from AWS to their own data centers, reducing costs and improving cash flow.

"And in this book, Andy talks about when intel got out of the memory business and into the CPU business and basically completely shifted the company."

Drew Houston references Andy Grove's book to draw a parallel between Intel's strategic pivot and Dropbox's need to refocus on what made it successful.

"They cut all this stuff, they kill mailbox, they kill carousel, they kill the developer platform, they way scale back the sort of enterprise aspect of Dropbox for business, and they refocus on the core customer base."

Ben Gilbert outlines the significant changes Dropbox made to return to profitability, including cutting extraneous products and services.

Key Theme: Dropbox's Market Position and Growth

  • Dropbox's market opportunity expanded from file syncing to team collaboration and workflow management.
  • The company's transition to lean operations and focus on core products led to financial stability.
  • Dropbox's IPO in 2018 was initially set at a lower valuation than previous rounds but experienced a first-day trading pop.
  • The bulk of Dropbox's revenue comes from business users, despite the majority of users being non-paying individuals.

"So the success of Dropbox and the Dropbox that you want to bet on is the one that is lean, mean, focused, building this very consumer oriented, easy to understand file sharing product."

Ben Gilbert emphasizes that Dropbox's success hinges on its ability to maintain a lean operation focused on its core product of easy-to-use file sharing and collaboration.

"And I think if I look at this from a venture investing perspective, when Sequoia led the seed round and then did the inside round for the a, they were investing on the promise of the future, but there was very strong data and signal that the market was there, that the product market fit was there, that there was a ton of growth ahead of the company."

Drew Houston reflects on the venture capital perspective, highlighting that early investments in Dropbox were based on strong market signals and product-market fit.

Key Theme: Dropbox's Public Market Narrative

  • Dropbox's S-1 filing and public market narrative focus on expanding its role in team collaboration and workflow efficiency.
  • Skeptics are concerned about the company's erratic past and the ability to effectively compete in the business market.
  • Despite concerns, Dropbox's IPO was successful, with a significant first-day trading pop.
  • The narrative around Dropbox's future is a mix of optimism and skepticism, with a focus on their potential to reimagine work collaboration.

"Dropbox went from it's a folder that you put stuff in that syncs to looking at the first page of their s one now with these crazy graphics and completely new brand as of just a few months ago, is unleash the world's creative energy by designing a more enlightened way of working."

Ben Gilbert highlights the shift in Dropbox's narrative from a simple file syncing service to a broader vision of facilitating creative and efficient work.

"Our market opportunity has grown as we've expanded from keeping files in sync to keeping teams in sync. Today, Dropbox is well positioned to reimagine the way that work gets done."

This quote from the S-1 filing indicates Dropbox's ambition to move beyond file syncing to become a leader in team collaboration and workflow management, a significant shift in their market positioning.

Key Theme: Investment and Valuation Insights

  • Sequoia Capital's early investment in Dropbox yielded significant returns.
  • The dilution per round indicates that early investors benefited greatly, while later investors owned a smaller portion of the company.
  • Y Combinator's partial share sale during the Series B round provided operational funds.
  • Dropbox's IPO valuation concerns were mitigated by the first-day trading performance.

"So what, sequoia make about a two and a half billion on the IPO."

Drew Houston discusses the substantial return on investment for Sequoia Capital, highlighting the success of early-stage investment in Dropbox.

"And if you look at YC and assume that a new story came out, that Y combinator sold about half of their shares in the Series B, when index led, they typically take 7% as part of the accelerator program, would have gotten diluted down to 4%. So their value of their shares would have been about 150,000,000 at that point, and would have been able to clear about 75 million for YC's operations by selling as a part of that round."

Ben Gilbert provides details on Y Combinator's financial moves and the impact on their returns from Dropbox's growth and eventual IPO.

Consumerization of the Enterprise

  • The concept of consumerization of the enterprise is relatively new.
  • Dropbox is likened to a consumer business with low conversion rates to paid.
  • It is also compared to an SMB (small to medium business) company like HubSpot.
  • The potential for Dropbox to become a huge company is acknowledged when considering these aspects.

"Company that looks like this, which is partially because consumerization of the enterprise is brand new." "And there's probably two comps within the structure of Dropbox. One is a consumer business, like a Spotify or Netflix or Pandora, albeit with extremely low conversion rates to paid. And the other is a sort of smv type company, maybe like HubSpot."

The quotes discuss the new trend of consumerization within enterprise environments and Dropbox's position within this trend. It also highlights Dropbox's dual nature as both a consumer and SMB-focused company.

Dropbox's Market Position and Challenges

  • Dropbox's similarity to Skype and its potential future growth are discussed.
  • Skepticism about Dropbox's ability to penetrate the big enterprise market due to competition from Box, Microsoft, and Google.
  • The difficulty for consumer-oriented storage services to monetize is noted.
  • Dropbox is seen as a "magical solution" for many organizations.

"I totally agree. Yeah. I think it's like Skype is probably the closest analogy here because maybe they can figure something out in the future." "There are a lot of organizations that look like acquired out there for which Dropbox is a magical solution."

The quotes express agreement with the comparison to Skype and recognize Dropbox's value to certain organizations, despite challenges in larger enterprise markets and consumer monetization.

Criticism of Dropbox's S-1 Filing

  • Ben Thompson highlighted three concerns regarding Dropbox's S-1 filing.
  • Lack of clarity and data, particularly the absence of monthly active user numbers.
  • The recent deletion of 100 million inactive accounts raises questions about active versus inactive users.
  • The sign-ups metric is criticized for not providing a clear picture of active engagement.

"There's three other sort of, I won't say skeptical, but narratives that the company wouldn't put forth that Ben Thompson called out this week either on exponent or when the s one came out, he did in the strategy daily update."

The quote summarizes the skepticism expressed by Ben Thompson regarding Dropbox's S-1 filing, pointing out the lack of transparency and potential issues with the metrics presented.

Dropbox's Key Metrics for Success

  • Active users may not be the best metric for Dropbox due to its integration with the operating system.
  • Metrics such as the percentage of storage quota used and the rate of conversion from free to paid are suggested as better indicators.
  • The importance of understanding the velocity of conversion and cohort analysis is emphasized.

"I think two better metrics would be one, some way to capture percentage of storage quota that users are using. And then the most important thing is the rate of conversion from free to paid and the velocity of that and cohorts of that."

This quote proposes alternative metrics to evaluate Dropbox's success, focusing on user engagement with storage and conversion rates to paid services, which are more indicative of the company's performance.

Dropbox's Strategic Direction and Cost Structure

  • Dropbox's indecision between focusing on top-line growth versus bottom-line profitability is discussed.
  • The company's massive cost-cutting through infrastructure changes is contrasted with efforts to expand into new markets.
  • The difficulty in calculating customer acquisition costs is highlighted due to the way Dropbox categorizes infrastructure costs for free accounts.

"It's difficult to understand sort of when we think about acquiring a customer for Dropbox, acquiring a paid user, how much money does Dropbox have to spend on them as a free user for years, storing gigabytes of their files before there's an upsell opportunity."

The quote discusses the challenge of assessing the true cost of customer acquisition for Dropbox, given the investment in free users before they potentially convert to paid subscribers.

Dropbox's Path to Profitability

  • Dropbox's financial performance has improved over the years, with decreasing losses and a path toward profitability.
  • The company's successful IPO and cash flow generation are noted.
  • The transition from relying on AWS to building their own data centers is seen as a significant achievement.

"They're continuing to have great free cash flow, and they're on a really great path toward profitability. Like, not just free cash flow, but, like, complete and total profitability."

This quote acknowledges Dropbox's improving financial situation, emphasizing the company's positive cash flow and the progress toward overall profitability.

The Need for Public Offering and Liquidity

  • Dropbox's IPO was not driven by a need for cash but rather by the need for investor and employee liquidity.
  • The timing of the public offering is discussed in the context of other tech companies needing to go public for similar reasons.
  • Dropbox had significant cash reserves at the time of their IPO, suggesting financial stability.

"They had to go public because even though they were very efficient with their fundraising, both investors and then also, but even more so, employees need liquidity."

The quote explains the rationale behind Dropbox's decision to go public, emphasizing the necessity of providing liquidity to investors and employees rather than raising capital for operational needs.

Tech Themes and the Future of Dropbox

  • The episode discusses tech themes such as the "bring your own software as a service" trend.
  • The impact of consumerization on sales models, with a focus on self-service channels.
  • The importance of solving real problems and creating products that "just work."
  • The potential for Dropbox to continue growing due to the increasing rate of new organization creation.

"Make something people want, exactly. Make something people want is how they phrase it. But when you're starting a company, when you're building a product, you have to solve a real problem."

This quote encapsulates the core philosophy of creating successful products by addressing real needs and ensuring ease of use, which is central to Dropbox's and Y Combinator's approach to business.

Evaluation of Dropbox's IPO and Ownership Structure

  • The discussion evaluates the success of Dropbox's IPO and the founder's ownership percentage.
  • The company's growth model and cash flow dynamics are considered key factors in minimizing dilution during fundraising.
  • The potential for Dropbox's market cap growth is debated, with a focus on the company's future prospects.

"This was largely because of this explosive growth that they were experiencing while still monetizing, mind you."

The quote highlights the significance of Dropbox's growth and monetization strategy, which contributed to the founder's substantial ownership stake at the time of the IPO.

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