KIRSTEN GREEN IS THE founder of the San Francisco–based Forerunner Ventures. Green has led efforts to raise over $250 million from leading investors and has invested in more than forty early-stage companies. Forerunner Ventures portfolio companies include or have included Birchbox, Bonobos, Dollar Shave Club, Glossier, Hotel Tonight, Jet.com, Warby Parker, and Zola. She currently serves on the board of directors of several Forerunner portfolio companies, including Glossier, INTURN, Outdoor Voices, Ritual, and Rockets of Awesome. Before founding Forerunner, Green was an equity research analyst and investor at Bank of America Securities (formerly Montgomery Securities), covering publicly traded retail and consumer stocks. She graduated from the University of California, Los Angeles, with a BA in business economics. She is also a certified public accountant and certified financial analyst.
1. “I’m always looking for things that are addressing a real need … high-margin products, real revenues, businesses that can scale.”
Green looks for certain attributes when evaluating an investment. The classic trilogy is product, market, and team. Core product value represents a solution to a real problem or need that is valuable enough to make people to want to pay for a product. This may seem an obvious attribute to look for, but the number of times venture capitalists have funded businesses that are trying to grow before having a valuable product is not small. A customer first recognizes core product value when they connect with the product in what is known as an “aha” moment.
Green also says that she looks for high-margin products. Businesses come in all varieties, and the gross margins generated by different activities vary significantly as well. Software companies and pharmaceutical firms typically have high gross margins. A company like Costco has low gross margins. Some companies make up for relatively low gross margins by selling a lot of products, and some do not. Some companies have high operating costs below the gross-margin line on the income statement, and some do not. If a business does have low gross margins, it does not have a lot of elbow room for operating expenses. Green is saying that life for a business is just better if it has high gross margins. Like many things in life, high profit margins can be a double-edged sword since it is much easier for a disruptive new business to attack an incumbent with high margins. Jeff Bezos has famously said, “Your margin is my opportunity.” In other words, Bezos sees a competitor’s love of margins and other financial ratios as an opportunity for Amazon: The competitor will cling to them while Bezos focuses on absolute-dollar free cash flow and slices through them like a hot knife through butter. If a business does not have a moat, its margins are at risk. Finally, Green looks for revenue and scalability in the businesses in which she invests. She wants more than an idea, and that idea should be capable of growing quickly into a large market.
2. “It is important for every founding team to be thinking about how to market in efficient, low-cost ways, as it is incredibly challenging to build a long-term sustainable business on paid marketing alone.”
Every business has a customer acquisition cost (CAC). A company that does not know its CAC is like a blindfolded poker player. Customer acquisition cost is a particularly important part of customer lifetime value since it is paid up front, which means cash going out the door in month one of the customer relationship. That cash going out the door may not be recovered for some time, creating a painful negative cash flow. If a business is able to grow revenue organically by word of mouth via direct customer-to-customer interaction, the customer acquisition cost drops. Customers acquired organically without paid advertising also remain customers longer, pay their bills on a more regular basis, and convert from free offerings to paid at a much higher rate.
3. “If you build an outstanding service or product, people will use it, they will talk, and others will come.”
A product that generates so much customer delight that experience with it produces positive customer word of mouth is hugely valuable for a business. The idea is a simple one (if a client loves a product, they will tell their friends) but not an easy one to realize. Conversely, if someone tells you about a product and it is not lovable, you will stop using it. Venture capitalists and entrepreneurs, like Andy Rachleff, point to Netflix as an example of a company that focuses on delighting its customers instead of being paranoid about competitors. In this way, Netflix is parting ways with the Andy Grove dictum of being paranoid about competitors, instead focusing on delighting customers. Rachleff quotes Reed Hastings as saying, “Being paranoid about competition is the last thing you want to do because it distracts you from the primary job at hand: delighting the customer.” Green is focused on adding companies to her portfolio that sell products that consumers genuinely love.
4. “It’s the entrepreneurs who have to give you permission to do this job.”
If I weren’t doing this, I would have gone to school for psychology and been a therapist. I am the friend that people want to tell their problems to.
The financial performance of a venture capitalist depends on his or her reputation with founders. To enhance that relationship, many venture capitalists act as mentors to their founders. Michael Bloomberg said once, “Over the course of one’s life, there are a few people who have a major influence on the way you look at the world and define what is most important.” He has described much of what a mentor can be in that sentence. The correct definition of a mentor is very broad and not limited to a formal relationship as some might imagine. Anyone who has a significant influence on your worldview can be a mentor. The venture capitalist Aileen Lee strives not only to be a mentor to founders, but also to “become a critical part of the life cycle of these companies.” Lee says, “I like to be part of the trusted pit crew they are looking to for guidance.”
5. “ ‘E-commerce’ is a bit of a dated word. I think it is part of the way in which we shop. You’ve got that huge new population of consumers that behave extraordinarily differently than any other population we’ve had before.”
Customers today have many choices and loads of information about their options. They do not need to accept an inferior offering. Technology and customer access to information have also made markets far more winner-take-all. If a CEO fails to see a shift in the market, his or her company can quickly find itself dead. Jeff Bezos understands this new environment well:
The balance of power is shifting toward consumers and away from companies…. The individual is empowered…. The right way to respond to this if you are a company is to put the vast majority of your energy, attention, and dollars into building a great product or service and put a smaller amount into shouting about it, marketing it. If I build a great product or service, my customers will tell each other. In the old world, you devoted 30 percent of your time to building an excellent service and 70 percent of your time to shouting about it. In the new world, that inverts.
Almost every customer is “showrooming” (comparing provider prices and quality) using tools made ubiquitously available by the Internet and a range of modern hardware devices. The days when a business could take advantage of an extensive information asymmetry to earn a higher profit on the sale of a good or service are either rapidly disappearing or already gone. The showrooming phenomenon has resulted in lower gross profit margins and an increasing focus on customer retention, which often takes the form of a subscription business model and a membership mentality. The theory behind this new approach is simple: By delighting customers on a more regular basis, treating customers as if they are members of a club, and tracking their engagement via a range of metrics, you reduce the risk of churn. Amazon Prime and Netflix are examples of businesses with a membership mentality. Another less obvious example is Costco, which makes the bulk of its profit on membership fees. The minimally marked-up merchandise in Costco stores (about 14 percent), the cheap hot dogs, and the free samples are all about delighting customers enough to renew their memberships.
6. “Now that people are bombarded with information, we are in a golden age where brands matter.”
The good news is that because of the Internet, we now have access to a great deal of information. And the bad news is that because of the Internet, there is sometimes too much information. People still need to make choices, and brands are helpful in that process.
An entrepreneur like Howard Schultz understood from Starbucks’s beginning that nothing created brand value and shareholder value more than strong customer word of mouth. Yes, Starbucks eventually invested in brand advertising in the mass media, but that was late in its history. As another example, Rich Barton’s company Zillow did not buy mass-market brand advertising until it had fifty million unique users.
7. “You increasingly cannot compete just on the product. To have a product that the consumer is willing to exchange money for is table stakes. So the thing to compete on is delivering a great experience.”
As products become more of a commodity because best practices and technology now spread so quickly, many businesses have discovered that market competition is increasingly based on price. Price-based competition can be ruinous. Green understands that one crucial way to escape price-based competition is to offer consumers a better experience since experience is harder to replicate than product. This better approach requires that a business create a regular series of “aha” moments during which the customer reconnects with core product value.
8. “Today consumers have access to so much more information than ever before; they have so many things influencing their decisions about their lives and about what they choose to engage in and spend their money on…. It’s a time when you can enter the market, and if you have the right proposition, you can be just as compelling, or more compelling, than something that has been around for a long time that doesn’t speak to the consumer in the same way.”
One reason why Green is so effective is that she has unique skills and experience that apply to retail and brands. What has been a graveyard for other investors has been a happy hunting ground for her. Some very prominent hedge-fund investors have been punished brutally by venturing into retail, via companies like J. C. Penney and Sears. Retail is hard. For example, Warren Buffett has said that many of his investment mistakes have been in retail because he strayed outside of his circle of competence. When hedge funds are losing to disruptive competitors in consumer markets, it is often a business backed by Green that is doing the disrupting.
9. “Birchbox and Warby Parker were the culmination of an ‘aha’ moment that was all of these things I had been looking for. The path to purchase is so different.”
A time of great change usually creates a tremendous opportunity for disruptive challengers of incumbents. It is volatility in valuations, risk, and uncertainty that create the potential for investors to outperform a market average. Keeping a customer in today’s hyper-competitive business world is often more profitable than paying to acquire a new customer. This increased focus on customer retention in no small part explains why so many businesses are shifting to a “lifetime-value” approach to valuing customers. Having to reacquire customers again and again for every transaction is not an ideal way to run a business today when customer acquisition costs are so high and customer switching costs so low. As a result, businesses are focused on delivering nearly constant value for their clients and keeping them engaged and happy.
Diagrams of a service development process must increasingly look like flywheels. Failure is an essential part of the process, which is a feedback loop. The model is “build, measure, learn, repeat.” Here is the scientific method at work but systematized with telemetry allowing for timely, accurate measurements like never before and cloud computing radically lowering the cost of the experiments.
10. “The way I stay out of the fray is to have a point of view, and to stand for something.”
We think we bring an edge in understanding the consumer and what will resonate with them.
With the way Amazon and eBay had become big companies and with the way people were embracing technology, I was like, it is so obvious that this is going to be a huge game changer in this space. The combination of these things is going to change what it means to retail, what it’s like to launch brands, what it means to connect with your consumer. That was the spark I jumped after very early on.
Venture capital investors can often be more successful if they find areas of specialization. This approach can enable the individual investor or firm to concentrate work, time, and talent in fewer areas and put more wood on a smaller number of arrow heads. Some venture capital firms like Maveron are consumer only. Other venture capitalists are primarily or even exclusively focused on enterprise startups. And other venture capital firms have prospered by being opportunistic generalists.
11. “Thinking about the acquirers, the state of the public markets, how a business is being valued—that’s an essential way to understand the overall ecosystem.”
Being a retail analyst at an investment bank in public markets, a certified financial analyst, and certified public accountant has provided Green with a broad background in business that is very helpful in her current role as a venture capitalist. Investors like Howard Marks believes that almost everything is cyclical. And it is clear that venture capital is no exception to this rule. People like Green who have seen business cycles inevitably turn know that sometimes growth is valued more than profitability by markets, and sometimes it is not. Sometimes cash is relatively easy to raise when you have a good business, and sometimes you can’t raise five cents even with a great business. Howard Marks likes to say that you cannot predict, but you can prepare. Having enough cash on hand to survive an inability to raise new money for a significant period helps prepare a company for adverse turns in unpredictable cycles. As Green says, it is “essential to understanding the ecosystem.”
12. “I think I rightfully thought Bonobos was in jeopardy several times.”
There is a stage in the life of a business that is the least glamorous but often the most important. Many companies particularly struggle for survival during the time between the launch of a startup and a financial exit. Scott Belsky calls this period “the messy middle.” Ben Horowitz refers to what happens during this time as “the Struggle.” Many companies almost fail before they succeed during this period. The venture capitalist often must perform triage and determine which companies to help and which have little hope. Aileen Lee notes,
Most successful startups take a lot of time and commitment to break out. While vesting periods are usually four years, the most valuable startups will take at least eight years before a ‘liquidity event,’ and most founders and CEOs will stay in their companies beyond such an event. Unicorns also tend to raise a lot of capital over time—way beyond the series A. So these founding teams had the ability to share a compelling company vision over many years and rounds of fundraising, plus scale themselves and recruit teams, despite economic ups and downs.
Missionaries survive this process far more often than mercenaries since mercenaries tend to find it overly taxing and difficult and often quit.