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Jason: Hey, everybody. Hey, everybody. It’s Jason Calacanis. Today on the program, twenty-five year venture capital veteran Andy Rachleff is on the program. As well as now the CEO of Wealthfront. We’re going to here all about his amazing 25 year career in venture and the new startup Wealthfront. Stick with us. It’s going to be a great hour.
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Jason: Hey, everybody. Hey, everybody. It’s Jason Calacanis on ThisWeekIn Startups. I am so excited that Hiscox Small Business makes my life so easy. We use the product here as you know. We have a great luxury. We only work with the best companies. Hiscox Small Business Insurance is one of those people. They provide customized coverage and competitive pricing. How easy is it to do? Well, good question. Here we go. On my laptop Boom. You go to the Hiscox site,HiscoxUSA.com and you fill out your basic information. I run a conference called Launch. This is my address in Culver City. These are my emails. This is how much insurance I’ve had in the past or none at all. Then Boom. That quick, that easy, you get your quote. $150 a month. Pretty cheap. Awesome. A million dollar liability, $1,000 deductible. You get all the bullet points here. Boom, boom, boom, boom, boom and I’m done. What a fantastic, fantastic easy to use product. We love it, we use it. Please go to HiscoxUSA.com/smallbiz. That’s right. Go to HiscoxUSA.com/smallbiz. Do not, do not, do not risk your dreams. Do not risk your team’s livelihood. Do not risk your investor’s money by being an amateur and not having small business insurance. There is no reason to avoid this discussion. You need to take the most difficult business discussions, things like legal issues. Like your terms of service, things that are boring like your accounting, legal stuff and of course insurance. You need to have insurance. What if someone trips and falls? What if somebody sues you? You need to have this insurance in place. You’ll be taken serious as a company. LIterally $20 a month this stuff starts at. There is no excuse not to have it. Hiscox has been a great supporter of the program. Thank you so much. Everybody follow @hiscoxsmallbiz. To get customized coverage and competitive pricing. It’s the only company in the US where you can get this like real time quotes. I think that’s very innovative of them. So they’re a very innovative company. Innovative enough to sponsor ThisWeekIn Startups. They know what they’re doing. They know where the startups hang out. They listen to the largest small business podcast in the world, ThisWeekIn Startups. OK That’s it. Thank you Hiscox. Let’s get back to the program.
Jason: Hey, everybody. Hey, everybody. Welcome back to the program. Today Andy Rachleff is on the program. He has been a venture capitalist for 25 years. Started investing in ’83, ’84, ’85 time frame.
Jason: The last venture firm was Benchmark. Obviously we all know that. Bill Gurley and a bunch of other great folks over there. Now doing Wealthfront. Welcome to the program.
Andy: Thank you very much.
Jason: So, tell me. 25 years in venture capital. I mean, what is the one thing you learned about making great investments?
Andy: You have to take risks.
Jason: There you go.
Andy: Without risk there isn’t reward.
Jason: So unpack that a little bit for us. In 25 years of investing, when did you find yourself… What risks didn’t you take that you wish you did is a good way to ask the question?
Andy: My investment idol is a guy named Howard Marks, who runs a hedge fund in LA., you might know called OakTree. He’s as well known for his writings as he is his returns, which are very, very good. He once wrote an article about investing which I think relates well to entrepreneurship as well. In the article he posited that investing can be explained with a 2X2 matrix. On one axis you can be right or wrong and on the other axis you can be consensus or non-consensus. Now obviously if you’re wrong you don’t make money.
Andy: What most people don’t realize is if you’re right and consensus you don’t make money.
Andy: The returns get arbitraged away. The only way as an investor and as an entrepreneur you make outsized returns is by being right and non-consensus.
Jason: Ah. So basically you have to have the courage of your convictions in the face of everybody else disagreeing with you.
Jason: Which is of course scary.
Andy: Yes. Which is why it’s not for everyone. A funny story is one of the companies Benchmark is well known for is Ebay.
Andy: I can tell you than until it went public all of our peers in the venture industry thought we were silly.
Andy: They would say, “Beanie Babies? Come on. This isn’t a real business.” So you make bets and you have to be willing to be wrong a lot. It’s one of the few industries I know of where you can be wrong 70% of the time and be brilliant.
Jason: That is true. The majority of startups fail.
Jason: Which means the majority of venture investments fail.
Andy: I wouldn’t say fail. They don’t make a big return.
Jason: OK. You’re right.
Andy: So I would say of the… You know there’s a two tiered market in venture. 2% of the firms generate 95% of the industry’s returns.
Andy: Among those 2% or 20 firms I would say the complete loss ratio is maybe 20%-30%. It’s not the majority fail. It’s that the majority don’t necessarily make big returns.
Jason: Returns. Yeah. It’s just sort of a push or something.
Jason: In the 80s venture capital is much different. It’s a much smaller pool of potential people you can raise money from and a much smaller pool of entrepreneurs. Is that correct?
Andy: Not necessarily. It’s a very cyclical business. So there was a cycle from 1980-1983 that looked a lot like 1996-1999. Only an order of magnitude smaller on every dimension.
Andy: An order of magnitude more of companies went public in the ’80-’83 time frame than had previously gone public. Just like an order of magnitude more companies went public in the bubble years. An order of magnitude more venture capital firms were created. An order of magnitude more capital was raised. So the exact same dynamics happen. When the windows shut on the IPOs all of a sudden there was a big contraction in venture capital. So from 1990 on we haven’t really seen the kind of contraction that we did in the mid ’80s to the late ’80s.
Jason: What was it like in the ’80s? It was mostly package software, operating systems, computer companies, Eagle Computer… What HP?
Andy: It wasn’t much software because people thought the assets walked out the door every night. Early in my career I started investing in software and that was considered very unusual and risky. So Silicon Valley was really built on semi-conductors…
Andy: … computers and storage.
Andy: Software started really gaining steam around 1990 as an investment opportunity.
Jason: What was it that made software breakout at that time do you think? Was there like a company that let it out of this sort of morass? Was it Lotus or just that…
Andy: It was the wave of MicroSoft, Lotus, Word Perfect.
Jason: Sure. Quattro Pro whatever.
Jason: All those desktop computers getting out there.
Jason: When you look back on the dotcom boom what do you think the lessons learned there were?
Andy: Well I think everyone knew what was going on. We were playing the game on the field. The funny thing is had you not played you would have been worse off. Even with the crash you would have been much worse off. So all the intelligent people knew it was going on. It was sort of a momentum game.
Andy: The question is, can you stop in time?
Jason: Do you feel we’re in that now? I mean you start to see the Facebook, Twitter, Pinterest… Well Facebook’s now public so it seems to… that seems to have hit a wall. You know. It wandered to like $42 then it started banging around in the teens. I mean, have we learned something there and that’s why Facebook sort of hit this wall?
Andy: You know there’s a great debate in the economist between Ben Horowitz and Steve Blank.
Andy: Where they discuss this exact topic. I came out on Ben Horowitz’s side. Which was, unlike the bubble we’re building really great companies in this environment. So are companies valued very highly? Yes. But you didn’t see multi-billion dollar companies created back then the way you do now. One thing that has been true through my entire career is that the best companies are over valued…
Andy: … by standard metrics. So I don’t think a bubble is an environment where things are valued highly, I think it’s an environment where crappy companies are values highly.
Jason: Yeah. So the companies are valued way disproportionally to the actual value that they’re providing.
Jason: The revenue.
Andy: So we have a lot of companies that are valued at arguably absurd values but they’re real businesses. If you look at Airbnb and DropBox and Square these are going to be multi-hundred million dollar businesses.
Jason: And when you say multiple hundred millions you mean in revenue?
Andy: That’s all I care about. I don’t think about market cap I think about revenue and profit.
Jason: What were the big misses of your career? What we call in the business now ‘the anti-portfolio.’
Andy: Oh God.
Jason: When you look back, what’s the gut wrenching misses? Did you have an opportunity to invest in Apple, Dell or…?
Andy: No. But I did in Cisco.
Jason: You did in Cisco?
Andy: Yes. And in Core Systems. So both of those…
Jason: What would have been the valuation of Cisco then and you when you could possible have exited or something?
Andy: Thanks a lot.
Andy: For bringing on this opened wound.
Jason: Yeah. It is…
Andy: I would bet it was… Well we along with probably some other 50 odd firms turned down the round that Sequoia did. They probably valued the company at $10M or $12M.
Jason: Wow. So they wind up putting $2M or $3M in and…
Jason: You don’t forget these numbers. For 30%.
Andy: I don’t forget those numbers. Because the funny thing is…
Jason: And they own what? 30% or something you think.
Andy: They owned approximately 30%.
Jason: Wow. Of a company that was ultimately worth hundreds of billions.
Andy: Well they didn’t hold on to it that long.
Andy: But it was an amazing return.
Jason: $12M to $12B maybe. Something like that.
Andy: Exactly. So you remember the ones you miss.
Andy: Because you can only lose 1X your money. So you can’t worry… You feel bad about the people who are in the companies but when you think about returns you’re much more focused on the ones that you missed and learning from those than the ones that failed.
Jason: Right. What was the signaling… What was the miss on Cisco? How do you miss a Cisco? John Chambers walks in…
Andy: It wasn’t John Chambers.
Jason: It wasn’t John Chambers.
Andy: The two founders…
Jason: Oh right. The two founders were professors or…
Andy: No. One… They both worked at Stanford.
Andy: One of them… I went to Stanford for graduate school and I now teach at the graduate school of business. So one of the two founders ran the computer center at the business school and she was the nastiest human being I had ever met.
Jason: She’s like, “You’re time is up on that computer.” This was back when people rationed computer time.
Andy: It was a mainframe. It was a deck system 20 mainframe.
Jason: Yeah. That was not an easy job to have.
Andy: No. It wasn’t but you didn’t have to handle it the way Sandy Lerner did.
Andy: So I got overly… If there is a huge lesson that I have learned in the venture business is that you shouldn’t get overly sensitive about the personalities of the people. You have to focus on the product market fit.
Jason: Right. In fact is it true in your experience, over decades of this, that the personalities who do create great things may not be all that affable?
Andy: More often than not.
Jason: It’s almost like the people who are more affable don’t make the great companies?
Andy: That’s what the stats would say.
Jason: Yeah. Pretty clearly.
Andy: But that doesn’t mean that you have to be that way. There are a lot of young people now who want to be like Steve Jobs. Thinking that’s what you need to do to be successful.
Jason: Ah. So there’s correlation and causation?
Andy: Yeah. I think there’s an attribution error there.
Jason: So explain that to the audience who didn’t follow what we just said.
Andy: I don’t think you need to be a jerk to succeed but many of the people who succeed act like jerks.
Jason: Got it. When you look back on Steve Jobs, obviously being in the Valley for as many years, you must have met him or interacted with him a number of times?
Jason: What’s your take on him. Obviously… built great companies, Pixar and Apple and Next.
Andy: Although I don’t think he had that much to do with the success of Pixar…
Jason: No. It was…
Andy: … in hindsight.
Jason: … he bought the right company.
Andy: The funny thing is… The real story was he bought the company for RenderMan software.
Andy: Because he thought 3D rendering software was going to be a really big deal. I think he bought it for $35M…
Jason: From Lucas.
Andy: Right. And he put something like $60M in to fund the losses.
Jason: Lost $100M.
Andy: Lost it all. He basically said to the team, “That’s it. I’m done. Fend for yourselves.” The only way they could fend for themselves was to start making commercials with this software. He didn’t drive that strategy. It was a necessity…
Jason: It was his jerkiness that drove it.
Andy: Well he wasn’t a jerk because…
Jason: He lost $100M?
Andy: He lost $100M and there was no product market fit.
Andy: It forced the people in the company to do something out of the ordinary to stay afloat.
Jason: Got it.
Andy: That was to do commercials using their software. I think they did a LifeSaver’s commercial which was an enormous critical and commercial success. From that they made a short movie.
Andy: From that they won the Academy Award then they became Pixar.
Andy: Then Steve jumped back in to make the most of it.
Jason: Got it.
Andy: But I don’t think he had the same impact that he did at Apple.
Jason: Interesting. When you look back on his career, did he pitch you on Next? Did you ever meet him during that time period?
Andy: No. He didn’t want venture capital.
Jason: He didn’t at that point? He had… He was just off the reservation?
Andy: I don’t think he was off the reservation. I think that he could command valuations that venture capitalists wouldn’t pay.
Jason: Ah. Interesting. He was that good…
Jason: … that he could just say, “I’m going to get whatever money I need from Wall Street or some alternative?” Individuals? Ross Perot?
Andy: Well his own money and… What was the founder of EDS?
Jason: Yeah. I don’t remember.
Jason: Ross Perot.
Andy: Ross Perot funded him.
Jason: Right. Interesting.
Andy: I think Sony or some japanese companies as well.
Jason: Yeah. So you left venture capital after 25 years to start a company.
Jason: Oh, no?
Andy: Actually I retired from venture capital to teach at Stanford.
Jason: That was the…
Andy: That was the idea.
Jason: Why? Why leave such an amazing business? It seems like it’s the greatest business ever. Not that teaching is bad.
Andy: No, no.
Jason: What was your reason? Yeah.
Andy: It was wonderful and I loved it. One of the wonderful things about BenchMark and one of the unique things about Benchmark is it’s an equal partnership. Amazingly given the success of the firm no one else has ever copied us.
Andy: So there might be equality among the senior partners but not everyone. So even if you join 17 years after the founding you’re an equal partner.
Jason: Wow. What does that mean? If I were to join next year and Bill’s like, “Ay, Jason. We play cards together.You’re a great guy. Do you want to join the firm?” I’m going to make the same amount as Bill Gurley?
Jason: That makes no sense.
Andy: It sure has worked for them, hasn’t it?
Jason: But it has worked pretty brilliantly. So what’s the thesis there?
Andy: The thesis is…
Jason: You were part of that thesis?
Andy: I was part of that thesis.
Jason: Yeah. So what is the thesis?
Andy: The thesis is it allows you to attract better people. Because if someone’s a superb potential partner would they rather join us as an equal partner or another firm as a junior partner? Well if they’re truly superb they don’t want to be junior in the hierarchy.
Andy: So it allows the firm to attract people like Bill, who came in after the original five. Peter Fenton, Matt Cohler. These are tremendous people. Arguable better than we were.
Andy: That’s what allows us to build a firm that sustains.
Jason: Interesting. But that means that people leaving… These venture firms… When people leave these venture firms, do they own the venture firm? How does it work? I don’t think the audience understands. Who owns Sequoia? Who owns BenchMark?
Andy: Well different firms operate differently.
Andy: But most firms, the partner has a stake in a partnership.
Jason: Got it.
Andy: OK? You vest that stake like an entrepreneur would vest equity. Except it vests over 10 years or 12 years not 4 years like entrepreneurs do. So if you choose to leave a firm typically, or if you’re asked to leave a firm…
Jason: That happens too.
Andy: That happens too. Then you will get what you vested in ownership in the carried interest in the percentage of the profits for that particular fund.
Jason: Right. So if you’re on BenchMark 7 and you’ve done BenchMark 3, 4 and 5 and you’ve done 75% of your time on each, you have 75% of what you’re carrying with you.
Jason: Seems fair.
Andy: The only way you can make this work, an equal partnership, is not to have the old guys suck up the equity and not work very hard.
Andy: Which is what’s common in the investment industry. You know the founders become old guys. They don’t want to work as hard but they want to keep getting the vig as you called it before.
Jason: The vig. Right.
Andy: Exactly. We had experienced that ourselves. We were young guys when we started BenchMark. We were all in our 30s.
Jason: You were working at another firm?
Andy: I was at a firm that decided to wind down, not raise another fund. We decided the only way that we could make this work is that if you are not willing to go 110% you had to raise your hand and opt out of all future equity but you would be fully vested in the funds in which you participated.
Andy: So having helped create this system, I believed in it firmly.
Andy: I benefit from it’s legacy. If BenchMark does well that reflects on me and my legacy in life. So I get no equity in future partnerships but I’m allowed to invest in the funds.
Andy: I think that’s a great deal. That way when I go to BenchMark to visit my partners they smile at me. Instead of nash their teeth saying, “Why is this guy coming to the office?”
Jason: That guy is taking the vig. He’s here to collect the vig, take the envelope and get out.
Jason: He’s an LP now. He believes in us so much now that he gave us control and all that kind of stuff.
Andy: It makes enough equity available for great guys like Matt Cohler and Peter Fenton to join the firm.
Jason: What makes a great venture capitalist today? What makes a bad one?
Andy: This is controversial.
Jason: Yeah. Good.
Andy: But I believe that 90% of the value added of the venture capitalist is making the right investment decision.
Jason: Ah. The selection?
Andy: The selection. Now I’m pretty proud of my contributions as a board member. But I think my contributions might have taken what was a 3X return to a 6X return. Maybe through the people that I recruited or the prospective or the network I could have helped the company get a better outcome. From 3X to 6X. That doesn’t move the needle on the economics of the fund surprisingly. Just like everything in life there’s an 80/20 to the returns. So 20% of the deals generate 80% of the returns. 6X doesn’t move the needle. You need the 10X, 20X, 30X your money outcomes. The ones that are the 20X outcomes are going to be great successes whether or not I was involved or someone who was less capable was involved on the board. Being a good board member might get you the next great deal for reputation but my colleagues in the venture industry don’t like hearing me say this but I think 90% of the value added is selection.
Jason: Interesting. So what’s the bad behavior, things that make bad venture capitalists? You are on the board of all these different companies, over so many years, you must have seen people just absolutely… I don’t know what the word is but screw things up or muck things up. What’s the… What should an entrepreneur be wary of? What’s the damage a VC can do?
GoTo Meeting: Ah, yes. Ay, yes. GoTo Meeting. This morning I was on a GoTo Meeting with one of my investors in Mahalo soon to be Inside.com. They were like, “What about this, what about that? Can you show me some of the stuff you’re doing for your new project Inside.com? I was like, “Oh. As a matter of fact I can.” Let me log into my intranet, securely. I didn’t have to give them all the passwords and send them to all these special URLs and IP addresses. I just shared my screen. He was in Germany. I was sharing the screen with him. His day was ending, my day was beginning. I just instantly put on my headphones. Perfect voice over IP. Crystal, crystal clear. Perfect HD Faces and perfect screen sharing. GoTo Meeting. I start the meeting on time every time, use the HD Faces it works great. You can use your iPad. I used that recently. You guys may remember in the episode where I was talking about the live crowdfunding app. I was actually using my iPad mini as a camera to view… Logged into GoTo Meeting… to view an iPhone. I mean this is getting crazy. It’s like however you think the product should work, GoTo Meeting makes it work. So thank you to my friends over there at Citrix. Meeting is Believing. You can try it free by going toGoToMeeting.com, click the ‘Try It Free’ button and click the promo code TWIST. GoTo Meeting, Meeting is Believing. We ran this contest to give away this very awesome… Oh, look. It’s got the new Lightening adapter too… this very awesome iPad. Gorgeous. Cause you know you can do it. I said, “Hey. Where would you like to do your meeting?” These are the top two. “I would like to host a GoTo Meeting while waiting in line at Disneyland.” Hmm. That’s a good one. I like that Chandra. Then Lin said, “I would take a GoTo Meeting in Central Park in New York City on a spring day. A beautiful spot in a wonderful city.” See now that’s a good one. She’s pandering to my New York City roots. But Chandra, on the other hand, is pandering to the fact that I was at Disneyland with my daughter recently. I’ve been spending a lot of time with Disney Princesses. This is going to be very hard for me to pick. Gosh. I’m going to go with Chandra actually. Cause you know what? I’ve been on line at Disneyland a lot these days. They said for some God forsaken reason I need to sign this. I guess that people want my autograph on the back of an iPad. Which is great. It says, “Hey. ThisWeekIn Startups winner. From your friends at GoTo Meeting.” So congratulations to Chandra. I will say… What should I say? I never have to autograph anything. Who am I? Bono? I gotta autograph an iPad? This is ridiculous. I’m Steve Jobs? What should I say? I’ll just sign it. “@jason.” I’ll put, “Congrats.” @jason. There you go. Look at that. Now I’ve ruined your iPad. No, it’s great. Every time Chandra uses the iPad, he can think of me and GoTo Meeting. Meeting is believing. Thank you GoTo Meeting.
Andy: You know, they almost can’t muck up a good company.
Jason: Yeah. They can try but they can’t.
Andy: They can try but they can’t.
Andy: Cause I think product market fit overcomes everything.
Jason: Product market fit overcomes everything?
Andy: This is a course that I teach at Stanford about the importance of product market fit to the success of a startup. If you address a market that really wants your product, if the dogs are eating the dog food, you can screw up everything in the company and you will succeed. Conversely, if you’re really good at execution but the dogs don’t want to eat the dog food, you have no chance of winning.
Jason: Interesting. What’s an example of that?
Andy: Name a franchise technology company.
Jason: Google search.
Andy: That was not a terribly well run company.
Jason: Yeah. Ebay.
Andy: Very poorly run.
Andy: They screwed up a lot of things.
Jason: PayPal? Disaster, right? Fraud everything.
Andy: But if people want the service…
Jason: It’s going to succeed despite…
Andy: It’s going to succeed. So if you believe as I do, that management’s job is to get to product market fit as opposed to execute, then they almost can’t… In the early days even if they screw up they can succeed. If you’re a horrible director you’re not going to stop the company from succeeding. Now they can be used as an excuse for a company that isn’t succeeding. That they got away.
Andy: I don’t buy that.
Jason: Yeah, exactly. So Wealthfront, what is it? Why did you start it?
Andy: Why did I start it? Well over the years, many of the people that I recruited in my portfolio companies and many of my former students… I’ve been teaching for more than 8 years now… would come to me for investment advice. I could never tell them to do what I do because I’m in the fortunate position to be able to afford access to the best investment products and services. So they couldn’t afford the minimums. So I could never tell them to do what I do. That always struck me as wrong. So after I retired I went on the board of trustees of my undergrad alma mater University of Pennsylvania and I’m on the endowment investment board. We have a $7B endowment at Penn. I knew all the people who ran the premier endowments because most of them were investors in Benchmark and I knew them from the venture community. They all basically invest the same way. One day I was sitting in a meeting and it struck me that through software, that some APIs started to become available that could make that style of investing available to the masses. So I didn’t want to start a company. It found me and I did it for the social good to try to democratize access to sophisticated financial advice.
Jason: What is the sophisticated thing that Penn has that a civilian on the street doesn’t have? Is it the information? Is it the structures? Is it the funds?
Andy: There are a few things. The great endowments, number one, understand how to do an asset allocation. Meaning, how do divide your money up among diversified styles of investment that are uncorrelated. How do you rebalance? Then within each of the classes of assets like stocks and bonds and venture capital and private equity they can figure out who the best managers are. But if you just do a mix of different styles of investments… Like the mix of your stocks and bonds and real estate and natural resources well and rebalance that’s 80% of the value. Most individuals can’t do that. Or if they can they have to pay a very big fee to get that advice.
Jason: What’s a very big fee? 1% or 2%?
Andy: If you go to Goldman Sachs or Morgan Stanley private wealth management you need $5M. A. To get them to manage your money. Then you pay 1%-1.5%. Now we have combined some of the most sophisticated experts in the financial world. Our Chief Investment Officer is Burt Malkiel, who wrote ‘A Random Walk Down Wall Street’ which helped the whole index fund trend. With sort of the best of Silicon Valley’s engineering to deliver the same service that Morgan and Goldman deliver at a $5K minimum and at a quarter of a percent fee.
Jason: So either 15%-25% of the fee and a fraction of the minimum?
Andy: Three orders of magnitude lower.
Jason: Yeah. So I can go in there, take $100K and have it balanced and rebalance over time and just model myself like a good Goldman professional might?
Jason: Do you educate me or do I just set it and forget it or both?
Andy: You just set it and forget it. You come to our website, you answer a 10 question questionnaire so that we can determine your tolerance for risk. We don’t ask you for your risk tolerance because behavioral economists have shown that we all overstate our tolerance for risk.
Andy: If I give you a portfolio that has higher risks than you really are comfortable with it’s likely to be more volatile. Therefore you’re more likely to sell in the bad times and leave a lot of money on the table.
Jason: Ah. So if I bought 100% of my money in stocks when the 2008, 2009 happens it goes down 50%…
Andy: You’re going to run for the exit at the wrong time.
Jason: … I sell at the wrong time.
Andy: Exactly the wrong time. So we’ve taken a lot of research from behavioral economics to develop a questionnaire to determine what your true tolerance is. Which is the critical input into something called Modern Portfolio Theory. Which is the basis on which endowments and other sophisticated institutions manage their money. Then we periodically rebalance it. Now that’s for $5K. If you give us $100K we do something called tax loss harvesting. Which is one of the two ways that Mitt Romney kept his taxes down. But this has only been available to very wealthy people. We’re bringing it down to people with $100K. That alone adds at least 1% to your annual after tax return. Then we’re about to introduce a new service where we give you a different mix for your taxable account or your retirement account. By doing that we add another half of a percent. So what’s really cool about what we do… Because we’re a software based financial advisor it constantly gets better. Whereas a physical financial advisor stays the same.
Jason: It doesn’t scale all that well.
Andy: It doesn’t scale.
Jason: Yeah. It’s sort of like you buy the new Tesla Model S you get new software every month. The car just gets better and better even though you’re not paying any money.
Andy: Exactly. So with us you get more and more features and arguably more amenities after tax return and we don’t increase the fee.
Jason: So what’s the most somebody’s put to work at Wealthfront? Somebody come in and say, “Here’s $10M. Go.”
Andy: Well we have a range of $5K to $5M.
Jason: Ah. Have people put $5M into Wealthfront.
Jason: If they put $5M in that probably means they have $50M or something else. $20M. Are they trusting you with the whole nest egg?
Andy: Well. We have applied a DropBox based business model to financial services for the first time.
Andy: So the way it works, just like DropBox gives you a certain amount of storage for free and then they charge you, so we manage your first $10K for free. Then only charge a quarter of a percent thereafter. For every person you invite, you and they each get an additional $5K managed for free. So if you invite 10 of your friends who join…
Jason: Or family members.
Andy: Or family members. You’ll have $60K managed for free. So what we tell people to do is try it with $10K and see how you like it. It’s a freemium model.
Jason: I’m just thinking, right now I’m paying 1% to my money manager. I’m kind of in that situation that you’re talking about. I was like, “Wait a second. 75 basis points compounded…”
Andy: Oh, it’s enormous.
Jason: It’s 10% or something after 10 years.
Andy: After 20 years it’s about 35% of the amount of capital that you invested.
Jason: Oh, my God. Killing me.
Andy: It’s an enormous number.
Jason: Yeah. Those fees seem so small but then…
Andy: So that’s just the low fee. When you start adding our sophisticated services like tax law harvesting and optimized asset allocation it gets even better.
Jason: What kind of support do you get? Obviously your money manager takes you to a Nick’s game or something.
Andy: I’m sorry. You don’t get that.
Jason: You don’t get that. You don’t get to go to a Nick’s game or go to a fancy lunch?
Jason: What if you need support or like more understanding of like what’s going on with my money? I just read the website, read the blog?
Andy: Well we try to make the product so simple that it answers all… We’re completely transparent. Which has never been done before. We try to make it so simple that you don’t have questions. But if you do we have financial advisors to answer phones or emails. Interestingly, no one calls. Because we’ve targeted our service initially at young people who work in tech, who can’t yet afford the minimums of a financial advisor.
Jason: Ah. So if they’ve got a quarter million dollars they got in some stock or half million dollars like, “I don’t have time for this. The Goldman guy doesn’t have time for me.”
Jason: “I’ll just put it here at Wealthfront.”
Andy: What mot people don’t realize is that more than 80% of the individual investor market is made up of delegators. People who want somebody to do it for them. Only 20% go to ETrade or Schwab and trade their own account.
Jason: I’ve been thinking about this myself. I know how the portfolio should be set up. I read about allocation and stuff like that. I mean not to the level that you guys are doing it but it’s like based on the 1% fee you can just buy these indexes or these devices. Is that what you’re doing is buying these devices? Are you actively managing the stocks or are you just saying, “Hey. Here’s that NASDAQ QQQ which is by a certain…” Do you actively trade, I guess would be way to say that?
Andy: No. We don’t actively trade. We allocate your portfolio… We custom allocate for your risk tolerance across 11 different asset classes. Each represented by a low cost ETF.
Jason: Got it.
Andy: So the average ETF costs only .14%.
Jason: I didn’t know that.
Andy: So we keep the cost way, way down which impacts your returns and added fees after tax.
Jason: Interesting. This company was invested in by a lot of famous people. I know Marc Andreessen and Bill Gurley. When a venture capitalist needs to raise money you pretty high credibility. Do you just go to your friends and say, “Hey. I’m starting something.” Or you have to pitch them?
Andy: Well they came to me.
Andy: Because they said, “What are you so busy with?”
Andy: Cause they’re wondering why either I couldn’t go to lunch or play golf with them. They knew that I was teaching but they didn’t know that I had started this company. When they heard what I was doing they got interested in the idea and they said, “Would you take some of our money?” That’s how we originally got financed.
Andy: Let me tell you, that’s unbelievably fortunate.
Jason: Yeah. Now how many people at the company? What’s the trajectory?
Andy: A little more than 20. We doubled… We don’t yet disclose our assets under management.
Andy: But they doubled just in the last 3 months alone.
Jason: Wow. Is the idea of you’re not going to be actively out there trying to find people? People will just tell their friends in the DropBox style.
Andy: Interestingly, in January more than a third of our new clients came from our invitation system.
Jason: Huh. Fascinating. So that’s another cost savings that gets passed on to your people.
Jason: You don’t have to sponsor a golf tournament.
Andy: The only way that we can charge such low fees is by driving the marginal costs to open a new account to zero. Cause if you think about it if you go to Morgan or Goldman…
Jason: There’s not enough money for you.
Jason: They’re only making $2,500 off of me a year.
Andy: Right. Well that’s if you have $1M.
Andy: At Morgan and Goldman they have to hire a lot of support people. They answer the phones, to call you every month. In our case you open an account online, you fund it online then we trade it electronically. So most people don’t ask for support. So arguably the marginal cost is zero which is how we can drive the fee down so low. It’s a classic disruptive business model.
Jason: How many different… You say I answer these 10 questions and you can tell me what my risk tolerance is. What if I look at that and say, “You know what? I think my companies doing pretty well. I’m going to have a good exit. I want to amp up my risk in my portfolio so I have more money to spend.”
Andy: We allow you to do it but we warn you. Literally, there’s a warning that says, “You understand this is really higher risk than you should tolerate.”
Andy: But we treat you with respect.
Jason: You can dial it up?
Andy: You can dial it up or down.
Jason: Are there settings like 1-10 risks? Have sort of you like created system that it’s easy to understand like there’s 10 ticks of risk?
Andy: There’s 20 ticks of risk.
Jason: Has anyone dialed up to 20?
Andy: No. Some people have dialed up… We increment it from 0-10 in half point increments.
Andy: So some people have jacked it up to 10.
Jason: Wow. So those people are… What percentage of the people screw around with the knob? Or do they just trust you on the quiz?
Andy: 70% trust us.
Andy: 15% dial it down and 15% dial it up.
Andy: Interestingly, younger people dial it down and older people dial it up.
Jason: Cause they want to get more money to retire and enjoy their life.
Andy: I guess. They shouldn’t do it.
Jason: It should be the opposite.
Andy: It should be the opposite.
Jason: Isn’t that what happened in the last financial crisis? A lot of people were going for their retirements. They got crushed when the market got cut in half. So the DOW was at 6,000. I don’t know where it bounced to the bottom.
Andy: I don’t remember. I try not to remember.
Jason: It’s like 6,000 right. People are loosing half of their money. Half their money in stocks. Then they think it’s going to go down another half. So I’ve got to preserve capital hear and move into cash.
Andy: Well you know there’s a very funny dynamic, a consistent dynamic among individual investors. In that they only buy after the market has gone up and they sell when the market goes down. Which is the exact opposite of what they should do. There is an organization called Dalbar that annually publishes an analysis of this behavior. They found that on average people lose 5% of return per year because of this behavior. If they just left it alone and didn’t touch it, forget rebalancing which adds even more return for the same level of risk. It costs you 5% a year.
Jason: Oh. Nauseating.
Andy: So try if you can… The beauty of rebalancing is that it’s forced contrarianism. Rebalancing says that if a particular asset class has gone up by too much…
Jason: If you’ve succeeded…
Andy: If you’ve succeeded then you should sale and if you failed you should buy. It’s the opposite of the human nature.
Jason: Yeah. Try to get that going.
Andy: Well we do that for you and that significantly improves your returns.
Jason: Awesome. What’s your take on the state of the economy? Everybody thought the world was ending back in 2008. Rebounded. Then everybody thought it was ending again. It just seems like the economy is… resilient?
Andy: First of all I should say, “I’m no economist.”
Jason: OK. You’re just building a wealth management company.
Andy: But the funny thing is, the premise behind what we’re doing is the economy doesn’t matter.
Andy: So modern portfolio theory, this methodology that most successful institutions manage their money by, which won the Nobel Prize in 1990, basically says you don’t look at the economy. For each asset class you look at the expected return, the expected volatility and the correlation with the other asset classes. Based on that you get a diversified portfolio of, ideally, anti-correlated investments. So we don’t worry about the economy because if stocks go up then bonds will go down. Or if stocks go down then maybe real estate will go up. It all balances itself out so you don’t have to worry about that.
Jason: There’s not a moment in time where everything goes down? Or is that very rare?
Andy: It’s extremely rare and it happened in 2008.
Jason: That’s when everybody was just, “Oh, my…” Is that what set the panic for the market?
Andy: Absolutely. The term in the financial markets was the correlations went to 1. So correlations among investments are vaulted on a scale of negative one to to one. So when the correlations went to one that really screwed things up.
Jason: It means that every time a bond goes down, the stocks went down, the gold went down…
Andy: That’s what was reported. Actually bonds went up.
Jason: Yeah. You know what happened to me?
Andy: Bonds went up 4% in 2008.
Jason: I went out of stocks in like 2006, 2007 cause I was getting nervous about it. I said, “Put everything in bonds. I don’t want to think about it.” I see all these signs of all these problems and I made 5% and 7% those two years.
Andy: So… exactly.
Jason: Then the market collapsed. Then when the market hit like… rebounded from 6,000 to 9,000 or 10,000 I was like, “I think the stocks look pretty good now. Let’s move in.”
Andy: You’re a great market timer. Very few people…
Jason: My broker was like, “You beat us.”
Andy: Very, very few people…
Jason: I don’t know why my market guy at AllianceBernstein said, “I don’t know why you’re using us when we should have been following you, in all honesty.” I was like, “Thank you for that but I don’t know exactly how I made that sense.” It was actually based on the idea that what people are doing is probably wrong.
Andy: That’s a contrarian.
Jason: I’m kind of a contrarian.
Andy: It’s contrarians who make money.
Jason: That’s it huh?
Andy: It’s the key to investing.
Jason: Yeah. This other key is crazy. I made the right decision so now I’m reversing it.
Jason: I made my money off of Apple shares. I was right that Apple would hit $800. Now I’m selling it. Cause everybody knows I’m right.
Jason: Then it moves on. So having spent 25 years in venture capital and then starting a company, what’s been the hardest, most challenging part? You were a picker. To your own description, 90% picking. Now you’re actually building.
Jason: A little bit harder than picking.
Andy: Let me tell you. It’s a hell of a lot harder. I thought I appreciated how the sausage was made in these companies because I was very engaged with my companies, hopefully in an appropriate fashion. I had no idea. Until you work inside the company I don’t think you can really appreciate it, number one. Number two, I didn’t appreciate how all consuming being a CEO is. I was really engaged as a venture capitalist but I could go out to dinner with my family, I could go to a game…
Jason: And forget.
Andy: … and forget. As you know, running a business…
Jason: It’s not possible.
Andy: It’s not possible.
Jason: You can’t turn it off.
Jason: It invades every crevice of your existence.
Andy: I think people were meant to either be investors or operators. Many people now come to me for advice as to which they should do. I think I was meant to be an investor.
Jason: So honest.
Andy: So I got us to a point through some luck and hard work to product market fit and our business is now really exploding.
Jason: You need a CEO.
Andy: We need a CEO. We just recruited Adam Nash.
Jason: I just like to say, “I’m not available.” I love the idea.
Andy: Thank you.
Jason: But I’m not available.
Andy: We just recruited Adam Nash who was the VP of product at LinkedIn.
Jason: Oh. Wow. Winner.
Andy: And E.I.R. at Greylock…
Andy: … to be our COO. Hopefully he’ll be our CEO by the end of the year.
Andy: He, in turn, has recruited some superb execs that we’re going to announce at the end of March.
Jason: So you move upstairs to become chairman?
Andy: Where I was really meant to be.
Jason: That is so honest but it’s true. It is so true.
Andy: Adam’s a heck of a lot better at taking us from this stage to next than I could be.
Jason: Let’s talk about founder stress and founder psychology. It’s a big topic today because, tragically, we had Jody Sherman, a founder who… Who knows exactly what the situation was but he killed himself. A lot of founders… I don’t know that we have a trend in founder suicide but we definitely have a trend in founder despair or founders being troubled.
Andy: I think that’s always been the case.
Jason: It always has been. Hasn’t it?
Andy: Ben Horowitz… Forgive me for continuing to pitch Ben. He’s a good friend of mine.
Jason: No. He’s great.
Andy: He writes… I love his blog. He wrote a blog post about the single biggest thing that you can do as CEO is not quit.
Jason: The number one contribution. “You’re an excellent CEO.” “Why is that boss?” “You haven’t quit.”
Andy: Because having experienced it yourself you know there are so many times where you say, “Oh. Is this really worth it?” But you’ve got to persevere.
Andy: You have to persevere if there really is a market opportunity for you.
Jason: Oh. So there is a time to quit?
Andy: I think there is.
Jason: What do you tell people when you are in your Stanford Business Graduate School class? When to quit?
Andy: When the dogs ain’t eating the dog food.
Jason: Is that is? Is it that simple?
Andy: When you just can’t figure out how to get them.
Jason: So you change the dog food recipe 100 times over two years. The dogs still don’t eat it.
Andy: You know, one of the biggest misperceptions… One of the things that I most disagree with the way things are taught in business school is that entrepreneurship is typically described as an entrepreneur looks at a market, tries to find a hole and develops a product. Those lead to what Howard Marks would call a right in consensus opportunity. They’re too easy to find. The non-consensus things are where… at least in technology… the entrepreneur sees an inflection point in technology which allows her to create a new product. Then the question is, who cares? What’s the market? So instead of starting with the market and then finding the product, the really big winners start with a product and find a market. So you have to… the en vogue term is pivot. But you’re basically keeping the same technology to try to find a market.
Jason: Iterate, iterate, iterate.
Andy: Iterate, iterate. If you can’t find a new market for that technology then I think you have to call it a day.
Jason: Ah. So mobile, processors, a screens. You try to make a Newton it’s not ready, it fails. You try again 10 years later.
Andy: Or you try to figure out is there a very small segment that will care deeply to get started.
Andy: Yes. That’s a perfect example. The biggest mistake that I saw entrepreneurs make when I was a venture capitalist, is that they went after the large market first. Now, I just wrote a piece inInc.com about the lost art of crossing the chasm. So in the 1990s the most popular business book in technology was the book ‘Crossing the Chasm.’
Jason: Right. Define what that means for people who haven’t read it.
Andy: In technology, as in most products, there is an adoption life cycle. Where typically products are initially bought by innovators then early adopters then the early majority, late majority and laggards. I’ll explain what that means. The innovators are the people who want to try everything but they don’t want to pay for anything.
Andy: Samplers. In enterprise it’s a corporate research lab. Amongst consumers it’s gadget geeks.
Andy: They’ll buy one of everything just to try it.
Andy: Early adopters are people who have a point of pain and are willing to buy a product if it solves that point of pain based…
Jason: They’ll overpay.
Andy: They’ll overpay based on that proof of concept.
Andy: So if you can prove to me that it really will solve my problem I’ll buy it.
Jason: So an audiophile might be the first to buy a CD…
Jason: Or a laptop by a traveling business salesperson.
Andy: Exactly. The early majority are the pragmatists. So where as the early adopters are the visionaries, the early majority… Think of this as a bell curve. Now we’re under the middle of the bell curve. They’re the biggest portion of the market, the only buy based on references.
Jason: Ah. So the sales guy who uses the laptop says, “This is incredible. I can do work on the road, on the plane. You need to get one.” For their mom, their cousin or any other person in the office.
Andy: If there are a lot of people who are already using it to the point that you get references from multiple people.
Jason: So when the iPhone first came out, “Maybe I’ll get it, maybe I won’t.” But when those 5 or 6 people tell you, “It’s incredible,” you buy iPhone 2.
Jason: Or iPhone 3.
Andy: Or iPhone 3. Now that is the big chunk of the market. The late majority are people who only buy something once something has become the standard.
Jason: The laggards.
Andy: Then the laggards never buy.
Jason: The laggards never buy. That’s the tail of the bell curve. Those are the dumb people. The bottom 15%.
Andy: I’ll leave that to you.
Jason: I’ll say it. Those are the dumb people.
Andy: By far the biggest chunk of the market is the early majority, the pragmatists, who only buy on references. So no matter how good your product is they will not buy it because they’re not going to buy based on proof of concept. They’re only going to buy based on references. The biggest mistake that I see entrepreneurs make is they try to sell to the early majority first. They don’t want to buy your product no matter how good it is.
Jason: You want the early adopters.
Jason: Which is the first… whatever that is. The first 5% of the curve.
Andy: Then as you build out what Geoffrey Moore, the author of ‘Crossing the Chasm’ calls the whole product. Which are the additional interfaces, features, support from third parties. Then you can cross the chasm from early adopters to the early majority.
Andy: So for us, we started with young people in tech who can’t afford financial advisors, the minimums.
Jason: They’re going to love it.
Andy: They’re going to love it.
Jason: And tell their brothers who are not in tech.
Jason: Or their mates from college.
Andy: A lot of people think we’re crazy. Why aren’t we going after the big chunk of the market given how low our fee is. Cause they’re not going to buy anyway until we have a minimum of $1B under management. Fortunately we’ll get there next year.
Jason: And you want those crazy early adopters to be absolutely in love with it. How do you know if they’re in love with it or not?
Andy: If they open more accounts or add more money to their accounts or invite their friends. Those three things.
Jason: How do you know what features to add to get them to do that?
Andy: Well we’re big believers in the customer development process. It’s part of what I teach in my product market fit class.
Jason: Yeah. Explain that. Yeah.
Andy: The idea is basically sell, design, build. Use the scientific method to build products. Meaning you develop a hypothesis, you test the hypothesis of the product idea and if prospects are willing to pay you for that then you develop.
Jason: So you tell them, “We’re thinking about making this. Would you pay for it?”
Jason: It’s like the lean startup movement.
Andy: It’s exactly the lean startup movement.
Jason: What do you think of the lean startup movement, the impact it’s had? Is that wise to pursue that? Is it wise with these caveats?
Andy: I think it’s phenomenal. I think it is just as crossing the chasm was a major step forward in the 90s for entrepreneurship. I think the lean startup methodology is a major step forward today. Now, will it make everyone a success? No. Because not every idea is great.
Jason: It doesn’t solve for that.
Andy: It doesn’t solve for that but it will minimize the amount of capital you need to get to success if you’re going to be successful.
Jason: Is business school worth it today?
Andy: You know. It depends. I think people go to business school for 3 reasons. First and foremost is to pivot their career. You know, if you’re an accountant and you really want to work in high tech marketing no one’s going to give you that job.
Jason: Yeah. You’re not going to get the chance.
Andy: You’re not going to get the job. But if you go to Harvard or Stanford, two weeks after you start your first year and you send your resumé to the same people who wouldn’t meet with you, you’ll now get an interview.
Jason: At the very least.
Andy: It’s not fair…
Jason: But it’s true.
Andy: … but it’s true.
Jason: I concur.
Andy: So the biggest reason to go to business school is to pivot your career.
Andy: Number two is the network that you build if you go to a good school. Boy, that served me unbelievably.
Jason: Where did you go? Penn, Stanford, Harvard.
Andy: I went to Stanford for business school.
Jason: But Penn undergrad?
Andy: Penn for undergrad.
Jason: Got it.
Andy: Then the third reason is for education. Is what you’re going to learn.
Jason: But Wharton’s a better school than Stanford, right? You would agree?
Jason: I’m just joking. Well Stanford vs. Harvard. People say Stanford is better than Harvard but Harvard has a better reputation.
Andy: I think it depends.
Andy: If you want to go into finance I think you want to go to Harvard. If you want to go into technology you want to go to Stanford.
Jason: It’s a very diplomatic… What’s the third situation? So you had pivoting your career, second the network.
Andy: Third is the education.
Jason: The actual knowledge.
Andy: The actual knowledge. Honestly, most people go for one and two.
Jason: Right. Cause the knowledge now is freely available on the web.
Jason: In fact, Coursera and EdX and what’s the other one… Udacity are all taking the courses at Stanford and Harvard and MIT.
Andy: As I said I’m a trustee at Penn and I’m on the faculty of Stanford and they were two of the four founding partners of Coursera.
Andy: So I was very involved with that.
Jason: What do you think the impact of that will be on humanity? The fact that it used to be… to sort of phrase it another way. It used to be people would say, “I was held back because I couldn’t get into Harvard. I was held back because I couldn’t meet any angel investors.” Now you have AngelLIst, Kickstarter. We’re democratizing the funding marketplace. If you put a great idea up on KickStarter nobody knows who you are or where you’re from. You can take all the courses from Stanford and MIT for free and get a certificate. What? What impact is that going to have on society?
Andy: Well I think it helps knowledge. It doesn’t address the first two of the three reasons that one goes to business school. It’s not going to help you pivot your career the same way.
Jason: No. You think if somebody sees a Coursera or an EdX certificate on machine learning that you scored a 97 at home versus going to the school. Do you think an employees will care?
Andy: Eventually. Look. I think it’s disruptive… In the Christenson sense it’s a disruptive technology. So I think ultimately it’s going to take a while to get there. Disruptive technologies tend to take longer. Which is counter-intuitive than non-disruptive technologies.
Andy: So ultimately it will get there. I think that as we move to an information economy people are going to need to learn how to write code or work in an environment where code is the primary value. The only way they’re going to do that is through things like Coursera and Udacity. I think it can play an enormous role in retraining the population.
Jason: Interesting. Andy this has been an amazing hour. Gosh, I was like, “Well Wealthfront is very interesting.” But gosh, your insights before and after the Wealthfront stuff were incredible as well. It sounds like It sounds like a great project. Everybody check out Wealthfront. I’m going to go there. I’m going to drop 5 dimes, 10 dimes in there.
Andy: Thank you. It’s free.
Jason: No. I’m telling you right now my poor broker at AllianceBernstein, poor Shane is probably going to be like, “Ahh.” But this can be good. I can negotiate fees now. Maybe I can negotiate my fee down a little bit. But yeah, I do think that you’re doing great work there. Congratulations on the great success there. I hear you got some big announcements coming up. So everybody go toWealthfront.com. What is the Twitter handle for Wealthfront?
Jason: You got it?
Jason: Usually it’s @wealthfront.com.
Andy: It’s such a bad name actually that it was easy to get.
Jason: It is? That’s a great name.
Andy: Well try to say ‘th’ before an ‘f’ five times fast.
Jason: Wealthfront, Wealthfront, Wealthfront, Wealthfront, Wealthfront. I am a professional broadcaster. I am now a professional broadcaster. I can do it. No. It’s a great name. You thinking about changing it?
Andy: No. We’re not thinking about changing it.
Jason: I own 20.com. So if you lowered it to 20 basis points you could use 20.com.
Andy: Well for many people it is only 20 basis points when you factor in the $10K we manage for free.
Jason: Exactly. Everybody go Wealthfront.com, put in 5 dimes and go see the magic. Everybody follow Andy on his Twitter account, @arachleff. Andy Rachleff, thank you so much for being on the program.
Andy: Thank you.
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- Gregory Hoffman
- Chris Rickard
- Eskil Steenberg
- Jay Moran
- Karim Sarkis
- Michael Davidovich
- Petru Marchidan
- Sam Drzymala