Social Capital reincarnated

Nine months ago, the once high-flying venture capital fund Social Capital made the bold decision to stop accepting outside capital and operate as a family office, in essence.

The co-founder of the outfit, brazen billionaire and early Facebook executive Chamath Palihapitiya, pledged to upend his investment strategy and make fewer but much larger investments as a means to improve his returns. Naturally, a near-complete exodus of Social Capital’s venture capitalists followed.

Today, the firm’s three founders, Palihapitiya, Mamoon Hamid and Ted Maidenberg, have gone their separate ways. Palihapitiya is rewriting the Social Capital playbook, Hamid is busy reinvigorating Kleiner Perkins and Maidenberg is building on top of the data-driven strategy and proprietary software dubbed “Magic 8-Ball” he built at Social Capital, with a new firm called Tribe Capital.

Quietly, Tribe Capital’s co-founders, Maidenberg and former Social Capital partners Arjun Sethi and Jonathan Hsu, have deployed millions of dollars in Social Capital portfolio companies like Slack and Carta, hired several former Social Capital employees and flexed a data-first approach that looks pretty damn familiar.  

Data or bust

SAN FRANCISCO, CA – OCTOBER 19: Founder/CEO of Social Capital, Chamath Palihapitiya, speaks onstage during “The State of the Valley: Where’s the Juice?” (Photo by Michael Kovac/Getty Images for Vanity Fair)

Social Capital began laying the foundation for a data-driven approach to investing years ago. Now, Tribe Capital is doubling down.

From its founding in 2011, Social Capital established itself as a contrarian fund out to “fix capitalism.” Its strategy and reputation as an up-and-comer unafraid of new tricks earned it stakes in Slack, SurveyMonkey, Box, Bust and many other admirable upstarts.

As the firm matured, its partners experimented. In 2016, its early-stage investment team made the daring choice to rely on data rather than gut-feel alone to make its investment decisions, confronting a timeworn ideology that the best VCs have a special skill-set that enables them to spot future unicorns.

Using an operating system for early-stage investing dubbed “capital-as-a-service” and the growth and data analysis tool Magic 8-Ball — a sort of QuickBooks for startup data — Social Capital forwent the traditional pitch process and rapidly evaluated thousands of companies on the basis of metrics and achievements alone.

Palihapitiya, Maidenberg, Hamid and the other members of the partnership were on a mission to do venture the right way. Until they weren’t.

“I found us incrementally drifting away from our core mission, and our strategy was increasingly that of a traditional investment firm,” Palihapitiya wrote last year. “It became harder to take the risks we took in 2011 and it became easier to play the same game as every other VC.”

At its peak, Social Capital employed a team of 80. Once Palihapitiya confirmed his intent to transition the firm away from venture, the team began to shrink, fast. Today, the firm employs 30, including partners Ray Ko, Andy Artz and Jay Zaveri. One-third of that number were hired after the big pivot.

The Social Capital diaspora 

Social Capital co-founder Mamoon Hamid left the fund in 2017 for Kleiner Perkins.

Social Capital’s former investors have since identified their second acts.

In the last year, Sakya Duvvuru, a former partner, founded Nellore Capital Management, and Carl Anderson, another former partner, started Marcho Partners.

Tony Bates joined Genesys as its CEO, Mike Ghaffary accepted a general partner role at Canvas Ventures, Ashley Carroll is consulting full-time, Kristen Spohn says she is still exploring opportunities, Adam Nelson joined South Park Commons as a venture partner and Tejinder Gill joined Collaborative Fund as a principal.

Hamid, for his part, resolved to re-establish Kleiner Perkins’ once-stellar reputation.

“Kleiner Perkins was a firm that was in desperate need of a change of its own,” Hamid tells TechCrunch. “It was a unique opportunity and I was about to turn 40. I thought, there is one thing I wanted to do in my career that I hadn’t done before and that was to turn around one of the best venture firms of all time.”

Hamid’s August 2017 departure from Social Capital represented the beginning of the end of the partnership. Though Hamid, a co-founder and leading dealmaker, asserts turmoil at the firm began after his exit. 

Nine months after Hamid made the call to move on, Arjun Sethi, who once led Social Capital’s early-stage investment team, made the same call as did Maidenberg and Hsu. Simultaneously, growth equity chief Tony Bates and vice chairman Marc Mezvinsky were said to be departing.

The mass exodus continued, culminating in Palihapitiya’s final declaration: Social Capital was finished with venture capital.

‘Magic 8-Ball’ — reborn

Maidenberg, Sethi and Hsu built Tribe Capital in the image of Social Capital. With similar DNA, the three men are attempting to upgrade an early-stage investment strategy they not only created, but nearly perfected.

“Those guys did a very good job working for me,” Palihapitiya tells TechCrunch. “I’m super proud to see them launch their own venture fund. It was a really important, defining experience for me; I hope they have the same level of success, if not more.”

But where Social Capital was mission-driven, regularly backing healthcare and education businesses, Tribe Capital makes no such claim. And where Social Capital leaned on data to inform its investment thesis, Tribe is putting its full weight into it.

We are believers that it’s hard to do a lot of things well, so we wanted to focus on one thing we are good at: early-stage venture with the approach of recognizing early-stage product-market fit,” Hsu tells TechCrunch. “At Social Capital we did that, but we did 30 other things, too.”

In total, seven former Social Capital investors and employees are working on Tribe. Georgia Kinne, a former Social Capital executive assistant, leads operations. Two former Social Capital data scientists, Jake Ellowitz and Brendan Moore, joined Tribe in the same role. And Alexander Chee, Social Capital’s former head of product development, is on board as an entrepreneur-in-residence.

Tribe won’t say how much capital they have raised yet or how exactly their three funds are structured, aside from confirming that only one is operating as a traditional venture fund. Paperwork filed with the U.S. Securities and Exchange Commission in late April, however, confirms a $150 million target for the debut venture effort. 

It’s been a year since Tribe began investing. In that time, it’s put money in Slack, Front, Cover and SFOX. Most recently, it participated in Carta’s $300 million Series E, which valued the business at $1.7 billion. All of these companies were previously backed by Social Capital.

Tribe is making deals of all shapes and sizes across industries, with a particular focus on enterprise, fintech and SaaS startups. In addition to deploying heftier sums to late-stage businesses like Slack, Tribe has made 10 seed bets of roughly $25,000 each, leveraging its data platform to make investment calls.

“The income statement and balance sheet are the lingua franca for an established company to communicate the financial health of its business,” Hsu writes. “These accounting concepts are often unhelpful when inspecting an unprofitable early-stage company. For a startup, what’s needed is a common quantitative language for what matters, namely, a quantitative framework for assessing product-market fit.”

Tribe’s quantitative framework is called Magic 8-Ball, a diligence tool for potential investments created by Maidenberg and Hsu during their Social Capital tenure. The tool measures product-market fit, growth trajectory and more of early-stage businesses, where, as Hsu mentions, financial data may be lacking.

“We use data like accountants; it’s not a magical AI machine,” Hsu said. “If other firms want to copy, by all means, they can try. We aren’t here to be antagonistic, we are here to be partners to founders and other investors.”

So far, Magic 8-Ball has poured through data provided by some 200 companies, with plans to hit 1,000 per year. In total, Tribe has deployed $100 million.

Tribe’s 8-Ball tool is said to be much more complex than the earlier model, according to a source with knowledge of the platform. It’s like when Yahoo engineers Jan Koum and Brian Acton left the search and email giant to build something even better, the source, who asked not to be named, said. That business became the messaging powerhouse WhatsApp.

Hamid, who’s not affiliated with Tribe but aware of their investment strategy, made a similar comparison.

“It’s like if you’re an engineer at Cisco working on WebEx,” Hamid tells TechCrunch. “You’re a great engineer but you can do better, you can [do your own] company. Guess what? That’s Zoom. That’s Eric Yuan . And Zoom is worth $20 billion and WebEx was worth $3 billion. That’s pretty. That’s the story of Silicon Valley. That’s creative disruption.”

Hamid, however, was careful to point out the differences between Social Capital and Tribe. The DNA may be similar but they aren’t identical.

Social Capital represented a new kind of venture firm in favor of creative disruption. Tribe Capital represents a second go, a sort of Social Capital 2.0 sans Chamath Palihapitiya.

Bogged down by the conflict surrounding its leader’s flair for controversy, Social Capital wasn’t set up to succeed. The Magic-8 Ball, on the other hand, may be just right.

“Why did we get back together instead of going elsewhere? That is a reasonable question,” Hsu said. “We had good job offers but we had a viewpoint of the world that we wanted to keep working on together.”

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SEC expands its war on cryptocurrency companies with a lawsuit against Kik

The Securities and Exchange Commission has sued Kik Interactive for the $100 million token sale the company announced two years ago.

It’s an expansion of legal actions that began last year as the SEC seeks to rein in companies that the regulatory agency thinks issued securities illegally.

In the lawsuit, the SEC claims that Kik conducted an illegal $100 million offering of digital tokens by selling the tokens to U.S. investors without registering their offer and sale as required under U.S. law.

The complaint alleges that Kik had been losing money for years on its online messaging application and that the company’s management predicted it would run out of money in 2017, precisely when it began laying the groundwork for the launch of its digital token, “Kin.”

The creation of an online marketplace selling through the company’s messaging service was financed by the sale of 1 trillion digital tokens to raise $100 million dollars.

Critical to the SEC’s case is the allegation that Kik marketed its Kin tokens as an investment opportunity, telling investors that rising demand would drive up the value of Kin and that Kik would work to boost that demand.

Kik was supposed to do that by building systems like a Kin transaction service, a rewards system for companies that used Kin, and by incorporating the tokens into the company’s existing messaging app. None of those features existed at the time of the offering, the SEC alleges.

The company also said that it would keep three trillion tokens that could trade on secondary markets and would increase in value as other investors speculated on the currency’s success.

“By selling $100 million in securities without registering the offers or sales, we allege that Kik deprived investors of information to which they were legally entitled, and prevented investors from making informed investment decisions,” said Steven Peikin, co-director of the SEC’s Division of Enforcement, in a statement. “Companies do not face a binary choice between innovation and compliance with the federal securities laws.”

At the heart of the case against Kik is the argument over the utility of the currency it offered. If it was simply a means of exchange on the company’s platform that customers used to conduct business between different parties, then the SEC’s argument might seem tenuous.

Andreessen Horowitz general partner Katie Haun laid out the arguments that Kik makes in its defense in a lengthy blog post published last month.

The company responded to the SEC in a Wells notice with a few different arguments. The first, that all currencies (and therefore all cryptocurrencies) are exempt from securities laws, is a pretty big swing. This argument will depend on whether or not a court accepts that a currency is by definition legal tender (Kin ain’t that).

Beyond that, Kik needs to be able to prove that it’s not a security by showing it doesn’t fit these three criteria: that it’s an investment of money, that everyone who invested is engaged in a common enterprise and that there’s an expectation of profits that results from its efforts.

Here’s how Haun, a former federal prosecutor and clerk for Supreme Court Justice Anthony Kennedy puts it:

Kik’s best argument seems to be (2), that there’s no common enterprise between them and the Kin purchasers. Courts have held that the mere sale of something, without promising more, doesn’t give rise to a common enterprise. Based on the public information I’ve reviewed, it’s not obvious that Kik was under any contractual obligation to the purchasers other than to deliver the tokens. Once that delivery occurred, Kin holders controlled their tokens and could use them how they pleased — whether to buy items or otherwise. And plenty did. Kik created a marketplace that was open and that was meant to achieve real exchange between participants, so Kik wasn’t necessarily a participant in all transactions. Thus, the SEC may have a hard time demonstrating common enterprise between Kik and token purchasers — unless they can come up with evidence showing that Kik had obligations to purchasers after token delivery.

What about (3), the expectation of profits through the efforts of others? In its Wells response, Kik tells a good story about consumptive uses, given its integration with the messenger platform, which had millions of users at the time of the token sale. Apparently, 20% of Kin purchasers linked their wallets to Kik to buy everything from games to digital products and services. That some participants purchased as little as 9 cents in Kin also seems more consistent with for “use” than for “investment”.

Kik’s defense hinges on who used the company’s cryptocurrency to make purchases through its messaging service versus which of the 10,000 acquirers of Kin currency at the time of the token offering were speculating on the cryptocurrency’s potential rise in value.

Here again, Haun’s explanation of what Kik needs to prove about the Kin offering is helpful:

But anecdotal evidence about why purchasers bought Kin won’t matter as much as the evidence around what Kik led purchasers to expect. This is because the case law focuses less on what was in a particular purchaser’s mind at the time, and more on what the seller “offered or promised” those purchasers. So the key will be what statements can be attributed to Kik before the sale — a great example of how PR, marketing, and other company building functions really matter when it comes to many crypto projects.

Kik says its primary marketing message focused on Kin’s use rather than on Kin as an investment, which makes sense since the project would only work if people actually used Kin. If that’s true, the SEC will need to contend with some of these facts:

  • 50% of participants in the token sale purchased less than $1000 of Kin, which seems more consistent with a consumptive use vs. investment purpose argument.

  • The way in which Kik structured things encouraged broad participation and discouraged speculation, for example, by capping the amount an individual could purchase to ensure more participants used its network.

  • It delayed its token sale to ensure functionality of the network first, making sure it could be used now vs. just in the future.

  • Since the token sale, the use of Kin has increased.

For its part, the SEC has its argument laid out in the statement of its charges.

“Kik told investors they could expect profits from its effort to create a digital ecosystem,” said Robert A. Cohen, chief of the Enforcement Division’s Cyber Unit, in a statement. “Future profits based on the efforts of others is a hallmark of a securities offering that must comply with the federal securities laws.”

As the SEC notes, some companies have already settled rather than go to trial. The Commission has previously charged issuers in settled cases alleging violations of these requirements, including Munchee Inc., Gladius Network LLCParagon Coin Inc. and CarrierEQ Inc. d/b/a Airfox, according to a statement from the regulatory agency.

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Slack narrows losses, displays healthy revenue growth

Workplace messaging powerhouse Slack filed an amended S-1 with the U.S. Securities and Exchange Commission on Friday weeks ahead of a direct listing expected June 20.

In the document, Slack included an updated look at its path to profitability, posting first-quarter revenues of $134.8 million on losses of $31.8 million. Slack’s Q1 revenues represent a 67% increase from the same period last year when the company lost $24.8 million on $80.9 million in revenue.

For the fiscal year ending January 31, 2019, the company reported losses of $138.9 million on revenue of $400.6 million. That’s compared to a loss of $140.1 million on revenue of $220.5 million the year prior.

Slack is in the process of completing the final steps necessary for its direct listing on The New York Stock Exchange, where it will trade under the ticker symbol “WORK.” A direct listing is an alternative approach to the stock market that allows well-known businesses to sell directly to the market existing shares held by insiders, employees and investors, instead of issuing new shares. The method lets companies bypass the traditional roadshow process and avoid a good chunk of Wall Street’s IPO fees.

Spotify completed a direct listing in 2018; Airbnb, another highly valued venture capital-backed business, is rumored to be considering a direct listing in 2020.

Slack is currently valued at $7 billion after raising $1.22 billion in VC funding from investors, including Accel, which owns a 24% pre-IPO stake, Andreessen Horowitz (13.3%), Social Capital (10.2%), SoftBank, T. Rowe Price, IVP, Kleiner Perkins and many others.

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Startups Weekly: There’s an alternative to raising VC and it’s called revenue-based financing

Revenue-based financing is on the rise, at least according to Lighter Capital, a firm that doles out entrepreneur-friendly debt capital.

What exactly is RBF you ask? It’s a relatively new form of funding for tech companies that are posting monthly recurring revenue. Here’s how Lighter Capital, which completed 500 RBF deals in 2018, explains it: “It’s an alternative funding model that mixes some aspects of debt and equity. Most RBF is technically structured as a loan. However, RBF investors’ returns are tied directly to the startup’s performance, which is more like equity.”

Source: Lighter Capital

What’s the appeal? As I said, RBFs are essentially dressed up debt rounds. Founders who opt for RBFs as opposed to venture capital deals hold on to all their equity and they don’t get stuck on the VC hamster wheel, the process in which you are forced to continually accept VC while losing more and more equity as a means of pleasing your investors.

RBFs, however, are better than traditional debt rounds because the investors are more incentivized to help the companies they invest in because they are receiving a certain portion of that business’s monthly revenues, typically 1% to 9%. Eventually, as is explained thoroughly in Lighter Capital’s newest RBF report, monthly payments come to an end, usually 1.3 to 2.5X the amount of the original financing, a multiple referred to as the “cap.” Three to five years down the line, any unpaid amount of said cap is due back to the investor. When all is said in done, ideally, the startup has grown with the support of the capital and hasn’t lost any equity.

At this point, they could opt to raise additional revenue-based capital, they could turn to venture capital or they could tap a tech bank to help them get to the next step. The idea is RBF is easier on the founder and it allows them optionality, something that is often lost when companies turn to VCs.

IPO corner, rapid-fire edition

Slack’s direct listing will be on June 20th. Get excited.

China’s Luckin Coffee raised $650 million in upsized U.S. IPO

Crowdstrike, a cybersecurity unicorn, dropped its S-1.

Freelance marketplace Fiverr has filed to go public on the NYSE.

Plus, I had a long and comprehensive conversation with Zoom CEO Eric Yuan this week about the company’s closely watched IPO. You can read the full transcript here.

Second Chances

Silicon Valley entrepreneur Hosain Rahman, the man behind Jawbone, has managed to raise $65.4 million for his new company, according to an SEC filing. The paperwork, coincidentally or otherwise, was processed while most of the world’s attention was focused on Uber’s IPO. Jawbone, if you remember, produced wireless speakers and Bluetooth earpieces, and went kaput in 2017 after burning up $1 billion in venture funding over the course of 10 years. Ouch.

More startup capital

Funds!

On the heels of enterprise startup UiPath raising at a $7 billion valuation, the startup’s biggest investor is announcing a new fund to double down on making more investments in Europe. VC firm Accel has closed a $575 million fund — money that it plans to use to back startups in Europe and Israel, investing primarily at the Series A stage in a range of between $5 million and $15 million, reports TechCrunch’s Ingrid Lunden. Plus, take a closer look at Contrary Capital. Part accelerator, part VC fund, Contrary writes small checks to student entrepreneurs and recent college dropouts.

Extra Crunch

Our paying subscribers are in for a treat this week. Our in-house venture capital expert Danny Crichton wrote down some thoughts on Uber and Lyft’s investment bankers. Here’s a snippet: “Startup CEOs heading to the public markets have a love/hate relationship with their investment bankers. On one hand, they are helpful in introducing a company to a wide range of asset managers who will hopefully hold their company’s stock for the long term, reducing price volatility and by extension, employee churn. On the other hand, they are flagrantly expensive, costing millions of dollars in underwriting fees and related expenses…”

Read the full story here and sign up for Extra Crunch here.

#Equitypod

If you enjoy this newsletter, be sure to check out TechCrunch’s venture-focused podcast, Equity. In this week’s episode, available here, Crunchbase News editor-in-chief Alex Wilhelm and I chat about the notable venture rounds of the week, CrowdStrike’s IPO and more of this week’s headlines.

Want more TechCrunch newsletters? Sign up here.

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Slack to live stream pitch to shareholders on Monday ahead of direct listing

Slack, the ubiquitous workplace messaging tool, will make its pitch to prospective shareholders on Monday at an invite-only event in New York City, the company confirmed in a blog post on Wednesday. Slack stock is expected to begin trading on the New York Stock Exchange as soon as next month.

Slack, which is pursuing a direct listing, will live stream Monday’s Investor Day on its website.

An alternative to an initial public offering, direct listings allow businesses to forgo issuing new shares and instead sell directly to the market existing shares held by insiders, employees and investors. Slack, like Spotify, has been able to bypass the traditional roadshow process expected of an IPO-ready business, as well as some of the exorbitant Wall Street fees.

Spotify, if you remember, similarly live streamed an event that is typically for investors eyes only. If Slack’s event is anything like the music streaming giant’s, Slack co-founder and chief executive officer Stewart Butterfield will speak to the company’s greater mission alongside several other executives.

Slack unveiled documents for a public listing two weeks ago. In its SEC filing, the company disclosed a net loss of $138.9 million and revenue of $400.6 million in the fiscal year ending January 31, 2019. That’s compared to a loss of $140.1 million on revenue of $220.5 million for the year before.

Additionally, the company said it reached 10 million daily active users earlier this year across more than 600,000 organizations.

Slack has previously raised a total of $1.2 billion in funding from investors, including Accel, Andreessen Horowitz, Social Capital, SoftBank, Google Ventures and Kleiner Perkins.

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