Andreessen Horowitz Case Solution
As Zenefits looks to expand its coverage and help startups and larger businesses manage all HR-affiliated tasks, the company is taking on $15 million in Series A financing from Andreessen Horowitz, Maverick and Venrock to go after larger, enterprise customers and to begin tackling international markets.
FORTUNE — When partners at the venture capital firm Andreessen Horowitz are late to a meeting with entrepreneurs, they pay for it – literally. That’s one of the rules established by co-founders Marc Andreessen and Ben Horowitz, former entrepreneurs themselves, who started the firm in 2009. Partners are fined $10 for every minute they are late to a meeting, a punishment that reinforces the belief that at Andreessen Horowitz, entrepreneurs deserve respect. Andreessen and Horowitz aimed to create the kind of firm they would have wanted to fund them in their startup days. Having raised three funds worth more than $2.7 billion–and investments that have included Facebook, Skype, Groupon, and Instagram–Andreessen Horowitz quickly has become one of the most influential firms on Sand Hill Road.
Fortune’s Adam Lashinsky sat down with the firm’s founding partners to discuss their business model, investing philosophies and role models. A lightly edited transcript follows.
ADAM LASHINSKY: So I’m here with Marc Andreessen and Ben Horowitz of the venture capital firm Andreessen Horowitz. It’s conventional wisdom in Silicon Valley that entrepreneurs and venture capitalists are not the best of buddies, and you guys were both entrepreneurs, were operating entrepreneurs several times over before starting your firm. And so the first question for you, Marc, is why were you interested in becoming a venture capitalist at all?
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MARC ANDREESSEN: At a certain point in your career — I mean, part of the answer is a personal answer, which is that at a certain point in your career, it becomes more satisfying to help entrepreneurs than to be one. That’s the introspective side of things, which I’m terrible at and so I’ll just like — I’ll refuse to talk about that going forward in this interview.
The other answer, though, the more sort of objective answer is we saw the opportunity to create the venture capital firm that we would have wanted to take money from had it existed. And so it’s sort of the classic case of we were a customer of venture capital for 15 years. So while we hadn’t been VCs, we had a very good idea of what it was like to be on the other side of the table and to actually be the consumer of the product, if you will.
ADAM LASHINSKY: And you took a purposely different approach to venture capital. Explain that.
BEN HOROWITZ: Right. Well, we had a couple of different ideas that led to that. And the first was founders make the best CEOs. And that was, at the time, like real counter-programming in that we had looked at all the really great companies, and they were typically run by their founders. And we really believed there was a reason for that, having been entrepreneurs, that the founder has the knowledge, they’ve got the commitment, they’ve got the passion, and that’s very hard to implant into the company. And then we designed the firm rather than being a firm to replace a founder with a professional CEO, we became the firm to teach the founder how to be the CEO and enable the founder to be the CEO.
And once we did that, there was a whole set of things that changed. So, the first thing was the partners needed to have experience running companies.
ADAM LASHINSKY: By partners, you mean your partners, the venture capitalists.
BEN HOROWITZ: The investing partners. If somebody’s going on your board and you’re going to be CEO, it will help if that person knows how to be CEO, who has done it before. So that we could help the founder get the skill set.
And then the second thing was professional CEOs have these incredible networks. They know people in the press and customers and executives and all these guys they can bring into the company. So we thought the firm ought to build the definitive network for Silicon Valley so that when a founder comes in, we can give him a network that’s better than any professional CEO. And those two things really ended up differentiating the firm in a big way.
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ADAM LASHINSKY: And so it may come as surprise to people that as a professional service firm, one of your role models is a completely different kind of professional services firm, a talent agency. Is that right?
MARC ANDREESSEN: Well, I would say we have kind of three firms that we really consider role models. So, one is [Creative Artists Agency], the talent agency CAA, and in particular CAA in the time period between 1975 and 1990, where it basically went from a complete upstart to being, you know, by far the market share leader in an industry that actually was 80 years old at that point. So our friend Michael Ovitz, you know, profound entrepreneurial accomplishment, we’ve learned a ton from him.
The other two firms we really aspire to be like, in addition to that, or draw inspiration from, is Allen & Company, which, you know has been — actually has had a continuous operating model itself. In its case, it’s actually existed since the 1920s.
ADAM LASHINSKY: This is the boutique investment bank.
MARC ANDREESSEN: Boutique investment bank. And it’s gone through generations of leadership and it’s evolved its strategy, but its culture and its way of operating and its values system have been, sort of shockingly continuous, especially in the context of Wall Street. And we work with them very closely and very much admire them.
And then the third is the original, the old, the 1910s, 1920s era JP Morgan, which played such a fundamental role in helping finance basically to build out of industrial America.
ADAM LASHINSKY: And what was unique about the culture of JP Morgan that’s of interest to you?
MARC ANDREESSEN: So the JP Morgan model actually encapsulates the culture, which is actually the model the now much larger firm actually carries to this day, which is first-class business done in a first-class way. So sort of the classic quote was JP Morgan himself testifying in front of the Senate, and he said, it doesn’t matter how much collateral anybody has, you know, basically you — in his case you lend entirely on the basis of character. And so he viewed it as entirely a people business and aspired to work with the best possible people, the people of the highest ethics and aspired for his firm to have that characteristic.
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ADAM LASHINSKY: One of the things that I think is probably not well-understood is that the venture capital industry, at least of the last decade or so, has not been a very good industry. Most of the firms have not done well. Is that true? And if so, why is that true?
BEN HOROWITZ: Well, it’s not just true for the last decade. I think it’s true for the kind of entire run of venture capital. And venture capital — and the reason is — and all the good venture capitalists always say that this is something we learned from the guys who came before us — it’s not an asset class. It’s not an industry. It’s the very small number of firms that the best entrepreneurs in the world are willing to take money from. And so if you look at the number of great entrepreneurs that get funded in a year, it’s on the order of 15. And so that means maybe there needs to be five firms. And if you look at the history of venture capital, returns are very persistent among the top five firms. And this is not true in, you know, mutual funds or hedge funds or anything else. You don’t have persistent returns across decades.
But in venture capital you do because it’s not picking the investments that’s the driver: It’s which firms do the best entrepreneurs want to work with. That’s the key thing that creates longevity, creates returns. And as a result, all the returns in venture capital go to a tiny number of firms and the same firms every year.
ADAM LASHINSKY: Now, this of course was true five years go, as well. Most people would agree that Andreessen Horowitz is now among the very top firms that entrepreneurs want to work with, although you’re too young to have the long-term track record to say that you have among the top returns. It was rather audacious of you, given this track record, to say, “We’re going to be one of those firms,” right?
MARC ANDREESSEN: Yeah, it was. And this was probably the biggest hurdle that we had to get over before we started the firm, which is exactly that. There have only been a couple of firms in the last 30 years that have been able to punch in. And so that’s what took us the most time. And what we thought we had figured out was a clearly different model and set of theories around how to attract the best entrepreneurs. That part of it does seem to be — I think objectively that part of it is working. You know, we still have to demonstrate, as you say, the sort of long-term financial returns that flow from that, but —
ADAM LASHINSKY: And talk a little bit about some of the things that you offer entrepreneurs. You obviously offer them yourselves, but you also have brought in-house a variety of services to help them be entrepreneurs, right?
MARC ANDREESSEN: Yeah, this is actually derived from the CAA model, which we could talk about at length. But the way we’ve implemented it is we have now 70 people in the firm, but only seven general partners. And so then if you take out –
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ADAM LASHINSKY: General partners are investors.
MARC ANDREESSEN: The actual investing partners. So the other 63 people are not general partners. And then if you take out administrative staff, and you take out back office, that gives you about 45 operating professionals in the firm who aren’t general partners. And there’s no other firm in this industry that has anywhere close to that. You know, other firms might have three or four. We have 45.
Those 45 folks are across five teams of professionals that work with our entrepreneurs. And those are across five disciplines: executive recruiting; engineering recruiting, so two different what we call talent functions; a function we call market development, which helps companies meet the big companies that matter in their industry. We’ll do on the order of 1200 briefings in our executive briefing center downstairs with Fortune 500 management teams, connecting them to the best and brightest new startups. And then fourth, marketing and PR, which is fundamental: How do you get your message out, how do you break through all the noise. And then fifth is corporate development: How do you raise money, how do you go public, how do you — you know, if it comes to it, how do you sell yourself, and how do you deal with all the issues around corporate finance.
And so an entrepreneur who works with us doesn’t just have a general partner on their board. They do have that, but in addition they’re basically surrounded by a team of experts drawn from these groups who help them through all the things that they probably have not done before.
ADAM LASHINSKY: So this is fascinating. If you think about this from an operating perspective, and you do, because you two are operators, these 40-some people are extremely expensive. They’re cost centers. And in order to pay them, your investments have to work. Is that correct?
BEN HOROWITZ: Yeah. Well, exactly. You know, it’s funny, and we took this model off of CAA, but it’s actually more applicable to us in a lot of ways. So in CAA, the way they were able to build a platform is the talent agents didn’t take any salary for the first several years, and they used the commissions that they got from the actors and actresses and screenwriters to kind of build the platform.
In our case, venture capitalists get paid two ways, not just one way. That was the only way the CAA guys got paid. One is what’s called the fee stream, which is the kind of money to pay salaries and operate the business. And the other is the investment, like the carry, the return on investments. We thought like if you’re an investor, you ought to get paid on investments, not just for being there. So Marc and I, when we started the firm we didn’t take any salary. We copied the CAA model. We used the fees to build out the platform. And even now, we like to pay the investing partners far below market on their salary and pay them over market in carry, or their money on investments, because that’s just a much better alignment of incentives.
ADAM LASHINSKY: Now, you are a — essentially a Silicon Valley only firm. This is your only office. Most of your investments have been nearby. So two questions. Is that intended to be for all time, and is that by design?
MARC ANDREESSEN: The way we describe it is we invest in Silicon Valley style companies. So we invest in the kind of companies that Silicon Valley seems uniquely good at producing at scale, you know, large numbers of over time. And so there’s that. We will then invest in those companies wherever they happen to be. We basically think two things. We think many of them have been and will continue to be in Silicon Valley, and even more broadly than that, in the US, as contrasted in many other countries. And then we also think that there is a huge benefit to us to have a single office, to have a shared culture, to have a real team dynamic in our firm, which is far easier to do with a single office. So the fact that everybody’s actually here every day, as compared to video conferences across multiple continents, we think helps — gives us the ability to have better thinking, hopefully.
ADAM LASHINSKY: You’ve also put a stake in the ground. You’ve said you’re interested in certain topics and you’re uninterested in other topics. Explain.
BEN HOROWITZ: Well, specifically we’re interested in what we understand. So like we have these like very simple principles in the firm. You know, like some experience required. If you’re going to mentor a CEO, you ought to have done the job, and similarly invest in things that you understand. And we have computer science backgrounds, so we try to stick to computer science, which really in laymen’s terms means software. But anywhere where software is the core intellectual property of the business, that’s the kind of thing that we like to invest in. So what we say is if you were to pull out the software team, if the company — does the company collapse. And if it doesn’t, then we don’t want to invest because we want software to be important to the company. We understand that product cycle. We understand those people. And that’s what we’re best at. So you won’t see us doing things like biotech or clean tech or, you know, we’re not degreed in material sciences. But anything that’s computer science very broadly, we’re very interested in doing.
ADAM LASHINSKY: But the implication of what you’re saying is that you two are computer scientists, but — and because of that you also don’t want to bring in a clean tech expert or a rocket ship expert or a biotech expert, which other firms have done and presumably they bring in good people.
MARC ANDREESSEN: Many of the best firms historically in venture capital have been multi-sector. And so exactly to your point, they’ve had their what they call the digital team or their information technology team. They’ve had their clean tech team. They’ve had their biotech team. And their argument has always been diversification across cycles, right? Sometimes optical networking is hot, sometimes new drugs are hot. And they can basically survive or prosper over the long run by being able to diversify.
Our view is that we reached a point — you know, I talk about this concept, I wrote about this concept a while back, called software eats the world, which is basically we think that the computer industry and the internet and software and smart phones have now reached the point where you can now build software-based startups, software-driven startups in many more industries than you used to be able to go after. And so we have software-based startups in industries as diverse as agriculture, real estate, financial services, education. And so we think — the way we think about it is the range of target markets we can apply computer science to are very broad and that our diversification comes from that. And then within the firm, we want deep expertise in computer science to be able to apply against all those markets.
ADAM LASHINSKY: I want to shift to management. Ben, you’ve written recently that punctuality is important to Andreessen Horowitz as a firm. Could you explain?
BEN HOROWITZ: Yeah. So one of the things that we didn’t like about venture capital as customers was the lack — what we thought was the lack of understanding and respect for the entrepreneurial process. And by that I mean, when you’re an entrepreneur, you’re working around the clock, you’re under incredible emotional strain, you have a lot of people depending on you, and then, you know, you go visit venture capital firms who say, “Oh, we love entrepreneurs. We’re pro-founder,” all these things. And the very first thing that you get is you go to meet with them and you sit in the lobby for 45 minutes waiting for them.
ADAM LASHINSKY: Because they’re very important people.
BEN HOROWITZ: Because they’re very important people. And they do let you know that in many ways. We just had this funny story about a tremendous executive and potential entrepreneur who was going through the Valley, and he met with a firm across the street. And when he walked into the meeting, the venture capitalist said, “Why are we meeting?” [Laughs] You know, so like, “Who are you?”
ADAM LASHINSKY: I’ve heard that before.
BEN HOROWITZ: “I’m the man. Who are you?” And that’s kind of a typical thing with venture capitalists. And we said, “Look, we want to make sure that everybody in this firm respects the entrepreneur and respects the fact that they’re going to be the ones who are making us the money, not vice versa. And we thought about — you know, being kind of operators, we thought about, “Well, how can we make sure that that happens?” And we think in terms of cultural cues. So the cultural cue that we’ve put in place is if you’re late as to a meeting with an entrepreneur, that’s fine. You will pay a fine of $10 a minute, so five minutes late, $50. And we tend to be on time, and we tend to respect entrepreneurs.
ADAM LASHINSKY: What’s the biggest fine you’ve collected so far?
BEN HOROWITZ: Well, I know I collected at least like a $180 fine from Marc one day, so —
ADAM LASHINSKY: I was going to ask if you —
BEN HOROWITZ: And now I think I’ve probably paid the second biggest fine.
ADAM LASHINSKY: Cultural cue, I like that expression a lot. In other words, you have a cultural value, and then you institute a policy around it that is symbolic in and of itself.
BEN HOROWITZ: Right. Because when somebody has to pay, you know, $80 for being eight minutes late to a meeting, they go, “Why? Why are you charging me so much money? I had to go to the bathroom. Like, what the hell?” And then we say, “Look, let us tell you this story of why we respect entrepreneurs and we respect their time.” And so every time somebody’s late we get to tell that story, and that really builds it into the culture.
ADAM LASHINSKY: Gentlemen, thank you.
BEN HOROWITZ: Thank you.
MARC ANDREESSEN: Thank you.