Dark Pools Come To Madison Avenue


This piece was originally published on Business Insider.

Dark pools on Wall Street were once heralded as a way for clients to get better deals on stock trades, but now they are associated with fraud and market manipulation.

In the latest dark pool scandal, Barclay’s was accused by the New York Attorney General of misleading investors by funneling trades into Barclay’s dark pool without prior consent.  Barclays lost over $5 billion in equity value just moments after the news was released.

For those who aren’t familiar, “dark pools” are essentially private stock exchanges. The theory is that a bank can match buyers and sellers from its own trading book, resulting in lower fees and benefiting both parties. There is also an argument that trading in stealth helps clients get a better price.

Both of these theories have largely been debunked. Exchanges are a prime example of a natural monopoly, where buyers and sellers get better pricing and trade execution as exchanges get bigger, not smaller. Dark pools have persisted, however, because they are huge money makers for Wall Street banks. They essentially allow the bank to trade against their own clients in secret, and not surprisingly they are now a source of ignominy.

Unfortunately it looks like Madison Avenue is following in the same footsteps.

Last week WPP announced that they are going to create the first “dark pool” in adtech. Rather than buy media on a public exchange, WPP plans to create a private exchange. The storyline sounds like a chapter from Goldman Sachs in 2001: “If you trade on our private exchange, you save on fees and get better pricing on media.” Unfortunately this ignores the logic around how marketplaces actually work.

In the interest of full disclosure, Greycroft has significant adtech investments that may be affected by this trend, but I am sure the announcement has other people scratching their heads as well. One obvious question is why would a publisher voluntarily move from Google’s exchange, where they get paid a lot of money, to WPP’s exchange, where they are promised less money?

In all likelihood, there are deals going on behind the scenes. In the past, tech companies have used guaranteed spend to move publishers onto new platforms, allowing a publisher to make at least as much money as they did before. Our adtech companies do this off their balance sheet and assume the risk if it doesn’t pan out. This would be the first time, however, that an agency would use client dollars to accomplish the same feat.‎

‎If you are curious about how this benefits clients, so am I. The one thing that is very clear to me, however, is how it could benefit a media agency that is on both sides of the transaction.‎

Therefore, buyers beware! Free and open buying and selling of advertising works best in a free and open market, not one where the owner is trading on the same system. Remember that you heard it here first, while there is still time to resist the power grab.

A Model For The Long Run

Back in 2006, when my partners and I set up Greycroft, every VC we knew insisted on 20% ownership, board seats, and being a “lead investor”.  We built Greycroft on the premise that there was a better way to do venture capital that didn’t require arbitrary rules for entrepreneurs.

Venture capital is a long term business, which gives investors an opportunity to build trust and equity over time.  For instance, I am still on the board of Collective, which was my first investment at Greycroft in 2007.  That was seven years ago.  In that span I met my wife, got married, bought a house, had a kid, and had innumerable other life events.  And seven years is not unusual in the venture business.  As of 2013, the average holding period of a venture-backed company from Series A to IPO was 8.1 years.  Some of the sectors we invest in have even longer holding periods, such as IT Services (9.1 years) and Telecom (16.8 years).

Every entrepreneur should stop and consider this point.  If you are successful, the person you raise money from may be your partner for your entire career.

With this in mind, my partners and I felt it was wrong to start a relationship based on arbitrary requirements.  In particular we always chafed at the notion that an entrepreneur needed to sell 20% of his or her company to a firm that he or she barely knew.

So we came up with a different model.  Instead of insisting on 20% at the beginning, we decided to syndicate every investment and focus on proving our value over time to entrepreneurs.  And instead of Greycroft insisting on board seats, we decided to only take board seats when an entrepreneur insisted on having us.

This may seem like a small change, but it puts the onus on us to perform. In order to build a meaningful position in a company we must become an entrepreneur’s best partner.  If we do that, entrepreneurs make room for us in secondary investments and follow-on investments, which allows us to build up ownership over time.

A lot has changed in the eight years since we started Greycroft, but to this day we are the only firm I know with this strategy.  And it has worked for us time and again.  We were originally a small investor in Buddy Media, owning just over 4% of the company, and when we sold the company four years later we were the second largest shareholder.  It was a similar story at Vizu, Pulse, Maker, Babble, Extreme Reach, M5 Networks, and a number of other successful investments.

What is native advertising?


In the past year we have looked at over 100 companies claiming to do native advertising.  If you haven’t heard of native advertising you will soon, because it is the hottest trend in online advertising right now.

I figured it would help to clarify what native advertising actually means.  I wouldn’t normally do this, but so many people who claim to do native advertising are definitively not doing native advertising.  Someone needs to define this segment.

There are two components to native advertising:

Part I: Native advertising is an integrated ad unit on a publisher’s website.  It is customized to fit into a consumer’s normal browsing behavior as defined by the publisher.  This means it looks and feels like any other piece of content even though it is sponsored.  The sponsorship is labelled, although it is often in small print.

But that is not all.

Part II: If a consumer clicks on a native ad, he or she must get the same action that results from clicking on any other piece of neighboring content from the publisher’s website.  THIS IS THE MOST IMPORTANT PART OF NATIVE ADVERTISING. Otherwise you just have a rich media company.

Here are two examples in case this second point is confusing.

Example 1: Let’s say you go to the New York Times homepage and click on a story.  That action always takes you to another page on the New York Times with the story. Similarly, clicking on a native ad on the homepage takes you to a deep link on The New York with the sponsored story.  The landing page must look and feel exactly like any other page on the New York Times and it must be on the New York Times domain.  In this context, a native ad does not hijack the consumer and take him or her off to another website.

Example 2: Let’s say you go to DrudgeReport, which has no proprietary content but is just a list of links to other websites.  If you click on a story, Drudge opens a new browser tab and sends you to that website.  A native ad would have exactly this same behavior.

Part of the problem is that agency RFPs are confusing the market because they do not differentiate between a rich media campaign (banner ads disguised to look like content) and true native advertising. I have seen a bunch of examples floating around.  Hopefully this helps with the definition.

High Frequency Media Buying

Archaeologists debate when the first stock exchange was formed – most say it was around 400 BC in ancient Rome. By that account the hand-to-hand trading of securities existed for over two millennia before the US Congress and SEC authorized the first electronic exchange in 1998.  Within a few years the physical stock exchange was replaced by computers, and computers changed everything.  The spread between buyers and sellers decreased by a factor of 100x, the volume of trades increased exponentially, data scientists became more wealthy than public-company CEOs, and protesters occupied Wall Street.

I mention this short history because the media business is following the exact same path.  And just like the financial markets, fortunes will be made and lost over a short period of time.  It is hard to grasp just how fast this space is changing – I have spent the last eight years looking at the market and still underestimate how quickly budgets are moving to electronic, biddable forms of online media.

The main term that people use to describe this movement is programmatic advertising.  Here is an overview of programmatic if you are interested.  In general, “programmatic” is a good descriptor, but it only captures a subset of the new phenomenon.

A broader term that we use at Greycroft is “indirect advertising”. Indirect refers to any ad revenue that originates without a sales team (usually through exchanges, networks, or affiliates).  Indirect advertising already accounts for the majority of revenue at Google and Facebook, and I believe it will eventually take over 90% of all online media budgets.

Why is this happening?

There are three main advantages with indirect advertising.

The first advantage is control over media selection/optimization.  In the direct world, agencies place a purchase order with a media company (i.e. agency says “we are buying 10mm impressions at a $5 CPM on your home page”) and the media company runs and optimizes the campaign.  As a result, every campaign gets some component of high-performing impressions and some component of filler.  Even if a publisher is doing a good job he or she can only optimize against impressions on-site, versus a holistic view across the entire campaign and multiple websites. Indirect media planning solves this problem by allowing an agency or network to pick each impression across all publishers, in real-time. This results in better performance.

The second advantage is speed of execution.  Let’s say that a consumer engaged in some action – shopped for a pair of sneakers, researched airfare, searched for a car – and an advertiser wants to respond to that signal with an ad. By the time an agency goes through the traditional, direct mechanism of insertion orders and paperwork the user has moved on.  As a result, all advanced targeting campaigns use indirect for faster execution.  This is quickly extending beyond display and into other forms of advertising as well, like affiliate and email marketing.

The third advantage is proprietary data.  Let’s say that you know something about consumers that no one else knows.  In the direct world, you have to trust a publisher to hold that data and run the media for you, or you could disguise it by using “pages” as a proxy for “audience”.  On one hand you give up your secret sauce and on the other you give up performance. In the new, indirect world you can keep this data to yourself and execute in stealth. This is particularly important as more advertisers use first-party data to buy media and don’t want to share their customer files.

The move to indirect will inevitably create winners and losers.  I expect that we will see more media companies with 50%+ profit margins thanks to indirect revenue.  However, these companies will look very different from traditional media organizations.  For starters, they will need much larger audiences to compensate for lower revenue per page, and many of them will be built on larger technical platforms that provide the publisher with infinite editorial and large network effects.

I also expect that product companies will be major winners. We see new products launching on the Internet every day – from toothbrushes to mattresses – and they are using indirect advertising to pinpoint an audience and measure a marketing funnel from impression all the way through revenue and repeat purchase.

Last but not least are the advertising agencies. The big agency holding companies foresaw this shift and built internal ad networks to capitalize on the trend. As a result they are making record profits today from digital advertising. But beneath all the big data hyperbole is a common piece of licensed software, which is simple enough for most advertisers to bring in-house. Over the long run I have a hunch that the Internet will do what it has always done best – eliminate the middleman – just like it did to the stock market circa 1998.

Rockets, Data, and DMPs

cartoon-rocket-6I am amazed at the recent ascent of RocketFuel, which has grown faster than any ad network I have ever seen. Budgets in the display media business are guarded by large agency holding companies, and agencies typically discourage clients from scaling this fast with a specific vendor. It looks like Rocketfuel has found a way around the industry stalwarts.

The secret is that Rocketfuel has done a good job defining success on each campaign. This involves a direct conversation with marketers to lay out goals, and afterwards performance can be measured directly against any other vendor, including an agency trading desk. To the extent a client wants low-cost clicks, Rocketfuel delivers, and to the extent a client wants email sign-ups, Rocketfuel can deliver those too. There are murmurs about the methodology underpinning all of Rocketfuel’s success, but at this stage they are arguably the best performance vendor in the market.

The one knock on Rocketfuel, which is actually a knock on every adtech company, is that they are not achieving the big vision of advertisers using their platform directly to buy media. Like every other ad network, Rocketfuel is currently bought campaign-by-campaign using insertion orders. The public market expects them to transition to a software model that is used in-house by clients. Unfortunately I think this vision is still 5-10 years off.

One hard part about buying media is the optimization that occurs mid-campaign. Typically the first dollars on every performance campaign are used to locate the audience, and then incremental dollars perform better once the system hones in. There are algorithms that automate parts of this puzzle, but it is largely customized for each client. Think about this problem from the perspective of a financial trader – if every stock broker used the same platform with the same algorithms, a smart hedge fund would swoop in and take advantage of that information to make a profit.  The same thing would happen in the media business if advertisers tried to take these systems in house today without investing in teams of data scientists.

A more realistic near-term vision is that marketers will bring data science in house over the next five years.  And only after that occurs will they venture into buying media. The market for these new “data science systems” is still emerging – the category includes a hodge-podge of acronyms like DMP (Data Management Platform), MDS (Marketing Data System), and TMS (Tag Management System) – but eventually a standard vocabulary will emerge to encompass it all.

Greycroft is keeping close tabs on the race to build the ultimate client-side data platform.  We have a few bets here already, such as Performance HorizonResonate Insights, and Tagman, and will likely make more over the next year or two.  We believe that this market is big enough to support a number of billion dollar outcomes.  Most importantly, the winner of the data war might also win the bigger fight to control media spend, and if played right someone could run the table here.  Based on what I am seeing in the market, my bet is that the ultimate winner is not going to be Rocketfuel.

A New State Of The Union

Welcome to my first political-themed blog post (with a mix of social science):

Every election cycle, research firms contact voters and ask questions like “How important is reforming Medicare and Social Security?” or “How important is reducing greenhouse gas emissions by 80% over the next 20 years?” I get these forms in the mail too, and on a couple occasions I even filled them out.

I always assumed that my party’s agenda would be the issues that registered voters feel strongest about. But I was wrong.

A few months ago I was introduced to a group called No Labels (you can check them out here) as well as the core research team at Pew. They shared the inside scoop about how political agendas are crafted in the US. Even though I don’t typically discuss politics I thought the math and psychology behind election results was interesting.

As it turns out, politicians use surveys to create “distance” between candidates. For instance, rather than focus on the issues that registered Democrats care most about, candidates will use a formula like: D – R + I. This takes the weight of the registered Democrat base, subtracts the weight of the registered Republican base, and then adds back Independents. Republicans do the same thing but superimpose D and R. As you can imagine, the resulting agenda is very polarizing.

The crazy thing is that this strategy wins elections. Candidates get support from their base and independents, and they distinguish themselves from their opponents on key issues. Julius Caesar called it divide and conquer.

The obvious downside of this approach is that nobody gets what they really want. The not-so-obvious downside, which many people are finding out right now, is that the winner is left with an ungovernable mess. It is virtually impossible to move the country forward when our President’s strategy is predicated on just how much he can make half of the population dislike him.

I included a snapshot below of the top 5 issues for each party when they employ the “distance” strategy. This is from my friends at Pew and No Labels. You will see how eerily familiar these themes are for current candidates in office.

Republican agenda (R-D+I):

1.) Balance the federal budget by 2024.
2.) Democrats and Republicans strike a grand bargain to reduce the deficit by reforming the tax code and entitlement spending by 2016.
3.) Solve Social Security and Medicare financial problems by 2020.
4.) Reform Medicare and Social Security so it is secure another 75 years.
5.) Cut taxes across the board by 2020 to generate more opportunity and jobs.

Here is the Democrat agenda (D-R+I):

1.) Raise the minimum wage to 12.50 and provide a minimum wage that provides a living wage.
2.) Cut income inequality in America by enacting tax reform that raises taxes on the wealthy and lowers them on the poor.
3.) Make the latest cures and medicines available to every American who needs them by 2020.
4.) Cut the number of Americans living in poverty in half over the next 10 years.
5.) Ensure that every child has access to high quality early education by 2018.

The team at No Labels is trying a different approach. They used the same body of research, but instead of creating “distance” they tried to find the issues that most voters agree upon. These are the results when you take D + R + 2 x Independent:

1.) Solve Social Security and Medicare financial problems by 2020.
2.) Reform Medicare and Social Security so it is secure another 75 years.

3.) Balance the federal budget by 2024.
4.) Create 50 million new jobs over the next 10 years.
5.) By 2018 bring back the 2 million manufacturing jobs lost during the recession.

If you are looking for a true national agenda, this is it.


Just A Little Bit of History Repeating


As we approach the end of 2013 I am feeling a little anxious.  If you are a gambler you might know the feeling, it is the same sense you get during a good run.  The dice are hot and the numbers keep coming.  Like a good sport you keep pressing.  But at some point you look up and see that you have an uncomfortable amount of money on the table.

At holiday parties my VC friends keep asking the same question – is it 1999 or 1997?‎  How much time do we have left on this bull market?  If you are a young partner at a venture capital firm this is not an academic question because almost all of your net worth is tied up in start-up stocks.

The good news is that I think we have at least another year.  There is even an outside chance that the market could get hotter.  The big unknown is how the market will react once the Fed stops stimulus spending next year. ‎

In hindsight, this all started with the financial crisis.  The Fed lowered interest rates to zero, and like many investors I moved money out of my zero-return bank account and into investment-grade bond funds.  The yields on those funds quickly went to zero because everyone else was doing the exact same thing, so I moved money into riskier bond funds.  The yield on those funds went down too.  After that I put money into equities.

As they say, “You can’t fight the Fed.”

The S&P 500 was up 23% in 2013.  Many people predicted that would happen. But who would have guessed that Best Buy would be the third best performing stock this year, up 230%?  The market is willing to overlook that Best Buy is shrinking, losing money, and every comparable company (Circuit City, CompUSA, Tweeter, etc) went bankrupt.  Similarly, many of the hot IPOs this year never made a profit before going public.  So much for the axiom about “four consecutive quarters of profitability ahead of an IPO”.  That just didn’t matter in 2013.

This is the hazard of Fed stimulus.  Returns flatten out on safe investments, encouraging investors to take more risk.

If you are an institutional investor sitting on the sidelines, 2013 must have been a painful year.  Even if you are right in the long run about the value of equities, you under-performed the market by a lot in 2013.

The reason I am bullish about 2014 is that the Fed inadvertently created a pressure cooker.  Money managers can’t afford to have two bad years in a row – that means they lose their job – so they will take more risk in 2014.  Maybe they invest in some IPOs. ‎ Maybe they dip into the private markets, putting money into “Pre-IPO” growth companies.

This is where it starts to get interesting for VCs like me.

The amount of money on the sidelines today dwarfs the markets from the 1990s.  McKinsey wrote a report in August of 2011 that showed the global financial markets grew by $100 Trillion since 2000, to a total of $212 Trillion, and almost all the growth was in the public and private debt markets.  All it takes is a few investors to make small adjustments, maybe take a little more risk in 2014, and the good times come again.

‎It is just ‎a little bit of history repeating.


Hello Walled Garden

Picture1When Twitter upgraded their mobile application this year, to a version called “New, New Twitter”, there was one significant change.  When I clicked on a link, rather than open my Chrome browser to load the web page, Twitter loaded a built-in browser.  This made a seamless transition between Twitter and the web, without ever leaving the app.

In the past few weeks Facebook updated their mobile app as well.  And guess what?  It now does the exact same thing as Twitter.  That means Facebook has a browser too.

So what is all the fuss about web browsers?

Back in 2010, Time Magazine wrote that browser technology was an altruistic pursuit.  If a user stayed on all Microsoft products – Windows OS, Internet Explorer, and Bing – the web would somehow work better for the consumer.

That is just nonsense.

The truth is that the browser captures data, which has become an important asset in the digital age.  Information about what websites people visit, commonly called “behavioral data”, provides the core insight to make online advertising work.  Owning a consumer’s web browser is the best way to see all of this behavior. (And, in case you were wondering, even the privacy advocates at Firefox get all their money from Google.)

Now that Facebook and Twitter come with mobile web browsers, their users are completely invisible to Google.  There is no Google Chrome activity and, most importantly, no search revenue.  It is a black hole.  And you can multiply that across a billion users.

This should get your attention.  “Facebook Browser” market share is not being measured by any official sources, but the company has so many page views that their mobile browser is likely #3 in the world right now.  The only mobile browsers with a larger footprint are Android and Safari because they are bundled with  your phone.

In addition to the data, another benefit of owning the browser is that you can determine what happens when a consumer mis-types a URL.  In the case of Google, if you type Nike into the browser (without the .com) they take you to a page filled with pay-per-click Nike ads.  If Facebook had a working search engine they could profit from this as well.

As a start-up investor, I think Facebook and Twitter’s new browser is good news.  Google has become dominant in too many categories for my comfort.  I don’t even know all the ways that Google is making money, but whenever I browse the web I know the meter is running.

When I look across the tech landscape there are very few companies that can mount an attack on Google. In this new iteration, Facebook and Twitter are using their mobile products to keep traffic for themselves. This is reminiscent of the walled garden strategy used by Prodigy, Compuserve, and AOL in the early 1990s.  And who knows, maybe this time around it will even work…

The VC And The Art World

In 2010, while the financial crisis was still unwinding, I traveled down to Tampa with my wife to visit her family.  On a back road not far from our hotel was a recently built housing complex.  These were beautiful, low-rise brick buildings, with landscaped lawns and tile roofs that reminded me of Florence.

The sign out front read:

2,000 square feet, 3 bedroom, 3 bathroom condos.

Starting at $349,999.



$120,000 or best offer.

I turned to my wife and said that we are moving to Tampa.

For the price of a one bedroom in New York City we could have 27 bedrooms, 27 bathrooms, and 9 kitchens. Our own Versailles!!

I often think of this Tampa measuring stick.  It is a reminder that there is a world outside of NY and SF where buyers are scarce.  Let’s call this the “Real World”.  In the real world there aren’t 47 people showing up at every open house and making all cash bids.

Someday I want to host a TV show called “The Price is NOT Right” where Midwesterners like me guess how much menu items cost at NY restaurants.  My favorite is the $7.50 toast (and yes, it is just toast) on the breakfast menu at E.A.T.

But that is small potatoes.

This past week in New York a Francis Bacon painting sold at auction for $142MM.  It is an oil painting on canvas, painted 44 years ago.  My wife has a Masters in Art History and, after a long explanation of the importance of the artwork, she told me that the price is crazy.

Paintings are not income-producing assets, so the only reason a painting is worth $142MM is that someone is willing to pay $142MM for it.  The art market is tricky.  Sometimes buyers lose interest in an artist for no apparent reason and values take a nosedive.

Earlier this week Snapchat turned down an offer from Facebook for $3BN.  Like the Francis Bacon painting, Snapchat is not an income producing asset (at least not yet).  I consider myself an expert in valuing start-up companies and I am struggling to figure this one out.

I have recently heard a new rationale for valuation.  It goes like this:  “Google will pay billions for this company.  Just look at Waze.”  You can also substitute Facebook for Google and Instagram for Waze.  Whenever I hear this it reminds me of the Francis Bacon painting.

This leads me to one final thought:  If a company doesn’t make money, is it art?

The Unicorn Effect

[Title borrowed from Aileen Lee's essay "Welcome to the Unicorn Club." It is worth a read.]


[Editors Note:  I don't know the guy in this photo.]

This past February we flew the entire Greycroft team to Utah for a ski weekend, which doubled as our firm-wide offsite.  In addition to the usual stuff, every partner had a chance to lead a discussion on a topic of his or her choice.  I picked a review of “Thinking, Fast and Slow” by Daniel Kahneman.

My goal was to help the firm identify decision-making bias.  My theory is that investors often focus on recent outcomes, which anchor us to an unrealistic notion of exit value.  I have circumstantial evidence that other VCs do this, but I mostly find myself falling into this trap all the time.

This subject is top of mind because in the past few weeks we have passed on, as well as outright lost, a number of competitive investments based on valuation.  It is not the first time we have gone through a spell like this, and it won’t be the last.

In my experience VC valuations generally fall within a close range – firms have the same information and we underwrite investments with similar return targets – until something changes in the market and valuations suddenly rise or fall.  We are in a phase right now where other firms have bid 200-300% higher than our proposals.  The only conclusion is that other investors have expectations that are very different from our expectations.

I am sure we are not alone.

In the past 24 hours both Fred Wilson and Aileen Lee have written blogs about the number of billion dollar outcomes, so big deals are top of mind.  If you read their posts you may even think that there are a lot of billion dollar outcomes out there.  This is the unicorn effect:  just because someone once saw a unicorn doesn’t mean that you will see one too.  If Aileen’s figures are correct, an early stage investor who makes 2 to 3 investments a year could invest for 400 years and still have less than a 50% chance of funding a single billion dollar outcome.

I also looked at the most recent data from my friends at CB Insights and PWC, and, in spite of the strong IPO market, the mean and median outcomes for venture-backed companies have not changed much year over year.  Based on their data, the median venture-backed outcome is still hovering around $55MM.  This number excludes both write-offs and companies that were acquired without a disclosed purchase price.  If you were to include those investments you would have a median outcome of zero, because fewer than 50% of VC-backed companies reach a successful exit.  On a similar “upside-only” analysis, the mean outcome is around $120MM.

Whenever we lose an investment on valuation I can’t help but think to myself that maybe the other guy is right.  Maybe we have missed the next Facebook or Google.  On the other hand, maybe a better strategy is to sit out a hand or two and see what the future brings. Time will tell.

1 of 9