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Mailbag: Silicon Valley Isn’t the Only Place to Find Startup Investments

Q: Are all the good investments in Silicon Valley?

A: No, not at all. Great startups can come from anywhere. But Silicon Valley produces more of them than anywhere else. And it’s no accident that the majority (20 out of 35) of the newest American unicorns (companies worth at least $1 billion) are based in the San Francisco Bay Area. It’s where most of the most successful venture capital (VC) firms operate, from Andreessen Horowitz to Kleiner Perkins to Benchmark to Sequoia. They’re part of Silicon Valley’s uniquely incredible startup infrastructure made up of talented coders, software engineers, and current and former billionaire and multimillionaire entrepreneurs.

A startup that scores an investment from one of these VC firms can access the firm’s network of technologists, marketers, financiers, supply chain experts and growth hackers.

A VC investment doesn’t guarantee success. (The majority of the startups these uber-successful firms invest in fail… or fall short of spectacular unicorn-like success – which is almost as bad.) But the Silicon Valley ecosystem does give startups a nice leg up on startups outside of the Bay Area.

Now, having said that…

I believe Silicon Valley is overrated. It puts too much emphasis on hypergrowth as opposed to smart growth that’s less dependent on huge dollar spends. Its advice and expertise comes with an obligation to listen and obey. And that’s increasingly becoming a point of contention. The consulting and technology firm Accordion surveyed 200 private-equity executives and portfolio company finance chiefs. Among the private-equity professionals surveyed by Accordion, 92% said they believe they are living up to the expectations of their portfolio company CFOs. But just 29% of the 100 CFOs in the survey agree. That’s one heck of a disconnect between the helpers and the helped.

Tobias Lütke, the CEO of Shopify, is not impressed with Silicon Valley either. Lütke says the costly fight for talent and property there is “one of the most pure examples of groupthink gone wrong.” He has a point. I’ve visited startups there that operate out of offices the size of broom closets. They simply can’t afford anything bigger.

Silicon Valley is in danger of losing its allure. Other tech hubs are expanding their startup ecosystems in impressive ways. Boston, Seattle, San Diego, New York City, Los Angeles and other urban centers offer a scaled-down version of what Silicon Valley does, but at half to a tenth of the cost.

And some of the biggest and most profitable startups are emerging in far-off countries like China and India. Both countries have huge populations of young people who are natural early adopters and love their smartphones and mobile apps.

So when I’m evaluating a startup, I really don’t pay much attention to its location. A great startup is a great startup. Traction, viral growth, a vibrant pipeline of customers… these things play wherever they’re located. The startups in our First Stage Investor portfolio come from all four corners of the country (plus a couple from Europe). I’d estimate about a quarter or so come from Silicon Valley.

Silicon Valley still offers unique advantages. It’s a long way from falling to the back of the pack. But it’s not the promised land either (if it ever was).

+ Early Investing Co-Founder Andy Gordon

Q: I’m new to startup investing. Where can I look for deals?

A: Since startup investing was opened up to everyone in the U.S. back in May 2016, the number and quality of deals have increased steadily.

Today there are more than 50 unique equity crowdfunding deals open for investment at any given time.

Here are some of the equity crowdfunding portals we look at on a regular basis.

When you’re starting out, I recommend simply looking at deals for a while. Look at how much “traction” (progress) a company has made and take note of the company’s “valuation” (the price you’re paying for equity). Be sure to check out the Q&A section and see how the founders interact with potential investors. You can learn a lot there.

When you’re ready to start funding some startups, invest small amounts at first. Minimums typically go as low as $50, with the most common number being $100. These low minimum investments allow you to diversify into a larger number of opportunities. Take advantage of it. The more quality deals you invest in, the better your chances at hitting a big winner.

+ Adam Sharp, Co-Founder, Early Investing

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T. Boone Pickens’ Real Legacy Has Nothing to Do With Oil

Success is not a straight line. Innovation has no end. No matter where you are in life, you can be successful if you have a plan for action.T. Boone Pickens

America has lost an icon. The news headlines will tell you that oil legend or oil tycoon T. Boone Pickens passed away at age 91 this week. But what the news headlines don’t tell you is that Pickens’ impact on business and investing went far beyond oil.

At Early Investing, we frequently talk about disruption. We talk about technologies – like software, artificial intelligence and robotics – that are going to disrupt entire industries. We talk about businesses – like Robinhood, Airbnb and Peloton – that are disrupting their sectors. We talk about medical marijuana, which will disrupt Big Pharma. And we talk about cryptocurrency, which is disrupting money.

Pickens embraced disruption. His first job was delivering newspapers. But he wasn’t satisfied with his route. So he bought the routes on either side of his. Not bad for a 12-year-old.

He lasted just three years working for his dad’s oil company. Then he went and borrowed some money, found some investors, and launched his own oil exploration business.

In the ’80s, oil was so cheap that it was less expensive to acquire new oil fields through corporate takeovers than to discover new oil reserves. So Pickens became a corporate raider.

“He’s only after the almighty buck,” said G.C. Richardson in 1985, according to The Associated Press. “He’s nothing but a pirate,” the retired executive of Cities Service added.

Pickens went on to try and disrupt the energy industry with natural gas in the ’90s and wind energy in the 2000s. He was a little early on both counts. But in turning to natural gas and then wind, Pickens proved he was even willing to disrupt himself.

“In business, I’m perhaps best known for my attempted corporate takeovers throughout the 1980s,” Pickens wrote in Forbes two years ago. “I have always believed that maintaining the status quo inevitably leads to failure.”

It’s a lesson we could all learn from.

One of the biggest “misses” in my career was the Internet Movie Database (IMDb). I was working for (the now defunct) USA Weekend magazine at the time. And my colleagues and I were attempting to convince our parent company, Gannett (also the parent company of USA Today), to buy IMDb. We could have gotten it fairly cheap (and for much less than the $55 million Amazon paid for it several months later). But the then-head of new media told us we “weren’t in the business of buying websites.”

Gannett, much like the rest of the newspaper world, wasn’t willing to disrupt its own business to succeed in the long term. If it had a little more Pickens in it, things might have turned out differently.

Netflix, on the other hand, is more than willing to disrupt itself. It turned from delivering movies on DVD via mail to streaming movies to streaming original content. Netflix gets the Pickens philosophy. That’s why it’s still relevant today.

The world has much to learn from Pickens. And lesson No. 1 is that Pickens’ biggest legacy has nothing to do with oil – and everything to do with disruption.

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Facial Recognition Technology Is Raising Serious Issues

A reader, Eton, asks, “Do you have any recommendations on facial recognition startups, or thoughts on them?”

I usually save questions like this for our Mailbag. But this is such a big and basic issue, I didn’t want to wait.

Facial recognition technology is spreading like wildfire. I first started to use it when my Google Photos app made it available a couple of years ago. It makes searching for people in your photo albums quick and easy. Apple uses facial recognition to enable users to unlock their smartphones. Banks employ it to verify transactions. And supermarkets use it to try to catch underage drinkers.

The technology isn’t perfect. Using a 3D mask of somebody else’s face can trick it. Hong Kong protesters have flashed laser beams at cameras to obscure their image.

But let’s assume facial recognition technology improves. Should we welcome widespread adoption? Is it something that needs to be regulated? Or even prohibited?

Frankly, the technology makes me very nervous. We don’t have to use our imagination to see its downside. China has built a network of facial recognition cameras to track and control its minority Muslim population (the Uighurs) in Xinjiang. It’s effectively a police state. The country also uses a dense infrastructure of cameras in its major cities to crack down on victimless crimes, such as traffic violations and jaywalking. Big Brother is watching.

But that’s China, you say. It could never happen here. Really?

Misidentifying a Threat

Imagine a wave of terrorism hitting the biggest cities in the United States. Arrests are few and far between. Feeling frustrated, the police in these cities rapidly install hundreds of facial recognition cameras on virtually every street corner. (San Francisco and Oakland are the biggest of a handful of cities that have forbidden agencies such as the police from using this technology.)

Now YOU are the one being watched. And this is a scenario where facial recognition technology’s faults become dangerous. The technology is most accurate at identifying white males. It errs more frequently when identifying minorities. So if it were being used to combat foreign terrorism, you’d better believe there’d be racial profiling going on.

This past August, facial recognition technology incorrectly matched 26 California lawmakers with images from an “arrest photo database” during a test, with more than half of the misidentified politicians being “lawmakers of color,” according to the American Civil Liberties Union.

If facial recognition tech is being used to combat domestic terrorism, then everybody would be under suspicion. Is this what Americans want?

According to a recent poll of 4,000 Americans by the Pew Research Center, it’s indeed okay with a majority of them. Fifty-nine percent said it was acceptable for police to use the technology to assess security threats in public.

I brought this issue up with my son, Nick (he’s a cop here in Maryland), last night over dinner at my favorite kebab restaurant. I asked him if he thought it was possible that the police could use the technology to improperly profile minorities. He said it’s a legit investigative tool that’s been very useful in solving crimes.

Then I asked Nick about Sen. Ed Markey’s (D-Massachusetts) letter to Amazon asking about its doorbell camera, Ring, and its relationship with law enforcement agencies. Ring has 400 partnerships with U.S. police forces that grant them access to the footage from the homeowners’ internet-connected video cameras.

“It’s voluntary. Users opt in. I don’t see any problem,” he said rather tersely.

I’d agree, if I knew that all cops were as honest and as good at their jobs as my son. I just don’t think that’s the case.

Proceed With Caution

But, right now, there’s not enough pushback to slow down adoption of this technology. In a House Committee hearing in July, members of the Department of Homeland Security (DHS) argued that face recognition and biometric surveillance is safe, regulated, and essential for the purposes of keeping airports and U.S. borders secure.

And by 2023, DHS estimates facial recognition will scrutinize 97% of outbound airline passengers. Its high estimate indicates that it’s assuming no additional regulations will restrict the technology.

These are serious issues. Keeping the peace is a big deal. Protecting our national security is one of the fundamental obligations of our government. But protecting our privacy and civil liberty is also a high-ranking moral obligation that requires constant vigilance… especially in the face of competing agendas.

Let’s proceed with the utmost caution. We’ve witnessed heinous crimes perpetrated in the name of the “motherland” (Germany, Russia, Bosnia, etc.). Giving up elements of our personal freedom should be a last-resort measure. A camera on every street corner is not the America I want for my children or grandchildren.

Let’s do our best to ensure it doesn’t come to that.

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Startup Investors: Watch Out for These Five Red Flags

Red warning flag

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Bitcoin Consuming Less Electricity

Bitcoin is getting more eco-friendly.

Despite more computing power being dedicated to bitcoin mining, less electricity is required to fuel it. Data from Statista shows that bitcoin mining energy consumption was 69.79 terawatt hours per year as of July 2019. In July 2018, it was 71.12 terawatts. And the current hash rate (the measure of computing power it takes to process bitcoin transactions) is almost 60% higher than it was back then.

There are two net positives here. One is that bitcoin’s hash rate keeps climbing. As we’ve written before, that’s a sign that bitcoin adoption is going strong and the network is more secure than ever.

The other is that bitcoin mining is consuming less energy. And this seems to be a growing trend. In June, a CoinShares study estimated 74% of bitcoin mining is powered by renewable energy. The report said the correlation between bitcoin mining and renewable energy makes bitcoin mining “more renewables-driven than almost every other large-scale industry in the world.”

Bitcoin’s improved energy efficiency is good for miners too. The CoinShares study found that “at current prices, the average miner is highly profitable, with even older gear and high-cost producers currently able to make positive ROI.”

Even Bitmain is trying to be more efficient. The company is the largest manufacturer of crypto mining equipment by market share. (It also operates a large bitcoin mining pool and has some problematic views on monopolizing the network.) Bitmain recently released a new chip that’s almost 30% more efficient than its last one. And back in March, Bitmain announced plans to set up 200,000 units of mining equipment in China to take advantage of the country’s cheap hydroelectric power.

Bitcoin mining has been criticized in the past for its high energy consumption. But bitcoin mining is more green than you think. And today’s chart shows that it’s getting greener.

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Mailbag: Don’t Take This Wall Street Investing Maxim as Gospel

Old Rusty Mailbox

Q: This sounds silly, but I just don’t know how you invest in what you know while still exploring new sectors?

A: Investing in what you know is a sound piece of advice as long as you don’t take it too seriously. I’m speaking from my own experience. For a long time, I treated it as gospel. Investing is hard and risky. Surely the more you know, the better your chance of picking a winner?

It’s a convincing argument. If you’ve lived in New York City your entire life and you like making real estate investments, are you better off investing in New York City real estate or real estate in, say, Moscow?

And yet…

I know a couple of very smart people who did just that. They ignored the opportunities in New York to buy apartment buildings in Moscow. And when you think about it, it makes a lot of sense. Because sometimes the sectors you know best are NOT home to the most exciting opportunities.

Should you just shrug your shoulders and turn your back on investing in artificial intelligence (AI), robotics, pharmaceuticals and medtech, autonomous driving, and a host of other sectors? That would be like ignoring the internet in the ’90s and early 2000s. Imagine missing out on Amazon and Google because you didn’t understand the internet.

Investing in only what you know has a big downside, doesn’t it?

TOO big, in my opinion.

So I don’t adhere to this maxim anymore.

But I also don’t invest in what I don’t know. Heck, for anybody who knows me, that’s a given.

My solution? Give yourself credit for what you do know. It’s probably more than you realize. If you take investing seriously, you’re constantly pushing the boundaries of what you know.

What I know now includes AI, robotics, autonomous driving and many other market spaces. I’m not the world’s foremost expert on any of these sectors. But I don’t have to be in order to successfully invest in them. I know more than the average nonspecialist. And I’m learning more all the time.

Learning is integral to startup investing. But so is making do with less. Less information… less of a track record… less access to hard numbers… and, frustratingly, less insight.

In the startup world, you have to fill in the blanks with your own part-science, part-art, part-instinct projections. Future profitability… market share… sales growth… What does the company say about these things? And how does that compare with what you think is possible or likely? Early investors with a little experience get pretty good at filling in the blanks.

I know I have. It’s not your traditional investing skill. It’s not science. It’s making judgments.

Invest in what you know? I know startups. I know how founders think. How they can overreach at times. And how they go about conquering big problems with a mixture of bravado and brilliant strategy.

Exploring new sectors is part of the fun and adventure. It also gives you optionality.

So don’t get hung up on a Wall Street maxim that’s a bit too simplistic for its own good. I see no contradiction in investing in what you know and exploring new terrain.

+ Early Investing Co-Founder Andy Gordon

Q: Why is the Fed making interest rates lower?

A: Because there’s way too much debt out there today. Student loans, home mortgages, credit card debt, corporate debt, and state, county and city debt.

A lot of people, governments and corporations wouldn’t be able to keep up with these loans if interest rates continued to rise or even if they stayed the same. We hit the breaking point at a fed funds rate of 2.5%, or before it.

Before the Fed lowered rates in July, the real estate market looked to be cooling quickly. Higher interest rates were going to hurt (or correct – depending on your point of view) the market. That’s a threat to the economy and the banks that make the loans, both of which the Fed believes itself responsible for.

Houses have become nearly unaffordable due to the Fed’s artificially low interest rates being in place for such a long period. The Fed created the 2008 real estate bubble and the last few before it. Now it needs housing (and other assets, like stocks) to remain expensive and unaffordable so that consumers don’t go underwater on their mortgages, lose money on stocks and stop spending.

The Fed is attempting to reinflate the asset bubble, and it thinks low interest rates and (probably) quantitative easing are the path to get there.

Lower rates and easier monetary conditions will probably “work” – at least for a while. I’ve learned to never underestimate the Fed’s determination. But considering the size of the debt pile we’ve built up, there’s going to be a rather nasty correction at some point. So the Fed will help postpone it as long as possible. It’s a heck of a pickle for everyone involved (including all of us).

+ Early Investing Co-Founder Adam Sharp

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News Fix: Binance Gets Dollar-Backed Stablecoin Approved

Welcome to a special back to school edition of the News Fix! We’ve been on the road looking for new investment opportunities, so we’re changing up the look and feel of this week’s Fix. In honor of school starting up again (not to mention traffic getting worse and temperatures dropping), we’re presenting this week’s headlines (and weekend reading) syllabus style.

For each topic we cover, the news has been divided into must reads, quick reads and fun reads.

Enjoy!

Cannabis

Must Read

Marijuana industry cranking up the lobbying efforts: You know an industry is achieving legitimacy when Washington politicians and lobbyists are willing to take large amounts of money from it. And it looks like the marijuana industry has reached that tipping point. It has spent $2 million so far this year on lobbying the federal government. The Cannabis Trade Federation ($482,500), Curaleaf ($400,000) and Surterra ($240,000) lead the way in spending (Marijuana Business Daily).

Quick Reads

Connecticut not likely to legalize marijuana this year (Hartford Courant)

Medical marijuana ballot petition collects more than 105,000 signatures in Mississippi (Clarion Ledger)

Fun Read

Utah revamping medical marijuana laws so county health department employees don’t act like “drug dealers” (The Salt Lake Tribune)

Startups

Must Read

WeWork’s IPO is officially a hot mess: Okay. CNBC didn’t actually say that. The Fix did. But it’s true. WeWork has been trying to go public this year despite the fact that it lost $900 million in the first six months of 2019. In its last fundraising round, WeWork was valued at $47 billion. But as it’s getting ready to go public, the company is being valued at $25 billion. And CNBC is reporting that even at that value, there isn’t much demand for WeWork shares. The IPO is in danger of being canceled. And SoftBank, which invested $5 billion in primary growth capital in WeWork at the $47 billion valuation, is not a happy camper (Bloomberg).

Quick Read

Airlines turning to tech startups to boost revenue (Reuters)

Fun Reads

Pet tech taking off (The Wall Street Journal)

The 28 best startups to work for, according to LinkedIn (Business Insider)

Crypto

Must Read

Binance stablecoin approved by New York regulators: The world’s largest crypto exchange by volume is getting into the stablecoin business. This week, it launched Binance USD (BUSD), a stablecoin backed by U.S. dollars. For every BUSD in circulation, a dollar will be held in reserve. What’s truly impressive about this launch, though, is that New York regulators have given BUSD the stamp of approval (CoinDesk).

Quick Reads

Apple keeping an eye on crypto (CNN)

Startup raises $23 million to improve anti-money laundering tools in crypto (CNBC)

Paxos launches crypto backed by gold (CoinDesk)

NSA working on a quantum-resistant cryptocurrency (Cointelegraph)

Burger King accepting bitcoin for online orders in Germany (Cointelegraph)

Fun Reads

Bitcoin mining booming in Siberia (CoinDesk)

Manny Pacquiao launches cryptocurrency (The Verge)

And finally, Coinbase is allowing its members to donate bitcoin to help victims of Hurricane Dorian (Yahoo Finance).

That’s your News Fix.

Have a great weekend!

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Are Passive Funds a Threat to the Market?

Dr. Michael Burry made a fortune shorting the real estate bubble in 2008. His bets against the subprime mortgage market were made famous in The Big Short, a bestselling book by Michael Lewis, which was later turned into a Hollywood movie starring Brad Pitt and Steve Carell.

Now Burry’s warning about another crash, which he says will be triggered by the rise of passive investing (buying very broad stock indexes like the S&P 500).

Passive index funds, led by the S&P 500 or the Russell 2000, now make up 45% of U.S. stock funds according to Morningstar via CNBC.

The other 55%, actively managed money, is largely mutual fund investors who have their money parked long term and haven’t yet switched to cheaper and more tax-efficient exchange-traded funds (ETFs). (By the way, many of these “active” mutual fund managers have portfolios that look very similar to the S&P 500. It’s an easy way to keep up with the index everyone’s watching.)

Dr. Burry says so much money being automatically fed into companies through passive investing is dangerous. Here are a few highlights from a recent interview with Bloomberg News

One of [Burry’s] most provocative views from a lengthy email interview with Bloomberg News on Tuesday: The recent flood of money into index funds has parallels with the pre-2008 bubble in collateralized debt obligations (CDOs), the complex securities that almost destroyed the global financial system.

Burry, who made a fortune betting against CDOs before the crisis, said index fund inflows are now distorting prices for stocks and bonds in much the same way that CDO purchases did for subprime mortgages more than a decade ago. The flows will reverse at some point, he said, and “it will be ugly” when they do.

Burry highlights that many of the companies in these indexes don’t have much trading volume. This could be a big problem during any sustained market sell-off, as investors rush for the door. Here’s another quote from Burry from the same Bloomberg article…

In the Russell 2000 Index, for instance, the vast majority of stocks are lower volume, lower value-traded stocks. Today I counted 1,049 stocks that traded less than $5 million in value during the day.

Burry continues his assault on index investing, which he calls “herding behavior.”

Trillions of dollars in assets globally are indexed to these stocks. The theater keeps getting more crowded, but the exit door is the same as it always was. All this gets worse as you get into even less liquid equity and bond markets globally.

I don’t know if passive investing will be the real trigger that Burry thinks it will be. I’m more worried about bloated balance sheets and unsustainably high profit margins.

But it does make sense that during any future crisis, the incredible amount of passive investments could make things worse. If everybody owns the same stuff and tries to get out, things could get messy and volatile. It’s another possible threat to keep an eye on.

I view the unprecedented rise of passive investing as just one of many possible threats to the U.S. economy and stock market. There’s also the escalating trade war, trillions of dollars of unpayable debt and slowing share buybacks.

These threats, along with the problems Burry points out, are keeping me out of indexes like the S&P 500 and the Russell 2000. I don’t own any of either.

What’s Burry Bullish On?

So what investments does Burry like? His top pick seems to be Japanese small cap value stocks. He sees bargains in smaller tech stocks there.

Interestingly, Burry says there’s more cushion under the Japanese market because the central bank owns such a large portion of the equity market. The Bank of Japan owns a shocking 77.5% of the ETF market in Japan. Burry said…

Ironically, the Japanese central bank owning so much of the largest ETFs in Japan means that during a global panic that revokes existing dogma, the largest stocks in those indexes might be relatively protected versus the U.S., Europe and other parts of Asia that do not have any similar stabilizing force inside their ETFs and passively managed funds.

I like Burry’s strategic investing thinking, but I am not a fan of Japanese stocks long term. Any investment thesis that involves the central bank buying stock is… strange to me.

Overall, though, I agree with his larger theory that passive investing could be dangerous. It’s one reason I’m also heavily invested in areas being shunned by others. As I explained in detail last week, I’m targeting private tech startups, cannabis, cheap emerging markets and crypto.

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Three Ways Tiny Startups Can Beat Amazon

Amazon Package

In between all the eating and drinking (I make no apology!) I did with family and friends this weekend, I squeezed in a couple of sets of tennis. And I noticed my tennis partner had a new pair of sneakers.

“Nice sneakers,” I commented.

“I got ‘em at a great price,” my partner said. “I tried them on at a discount store at the mall, then bought them on Amazon for 20% cheaper.”

And that is why traditional retail is scuffling, in a nutshell.

Brick-and-mortar stores and e-commerce companies alike are trying to compete with Amazon.

But Amazon’s overwhelming market power begs the question: Is it even possible to compete?

Successful startups have to have outstanding leadership, an excellent product and a growth strategy that makes sense. For those startups that figure out a way to do all that and compete with Amazon, the prize is stunningly large. This year, the global e-commerce market is expected to reach $3.535 trillion. By 2021, it should approach $5 trillion.

Many retailers – both traditional and online – have tried to tackle Amazon head-on. But few have succeeded.

E-commerce pioneer eBay is managing to hang on, but for how much longer? Its market cap is $33 billion compared with Amazon’s $883 billion. Investors are willing to pay 75 times earnings for shares of Amazon – for shares of eBay, only 15 times earnings.

Investors are more optimistic about relative newcomer Shopify. Its shares have grown in value by 163% over the past 12 months compared with Amazon’s 12% drop during the same period. Shopify has been able to grow by offering merchants the same technology and capabilities as Amazon, but with more control.

That’s one competitive strategy. Other strategies target particular kinds of retail where Amazon lags behind. And some small startups are seeing initial success against the behemoth using this approach. Here are three kinds of retail that have gotten my attention through the amazing startups we’ve recommended to our First Stage Investor members. (If you’d like to learn more about these companies, subscribe to First Stage Investor.)

Lifestyle retail: In the lifestyle retail space, brands try to embody the values, aspirations and opinions of a group or subculture. Amazon’s boilerplate listings don’t lend themselves to lifestyle branding. And one company in the First Stage Investor portfolio is taking full advantage. Its first product was high-end jeans. And it’s now rapidly expanding into other lifestyle brands. Is it worried about poking the sleeping monster? Not really. “Amazon is used to dominating everything it touches, but it’s off to a slow start in the retail lifestyle space,” its founder told me. It views Amazon less as competition and more as a possible buyer of the company down the road.

Highly regulated retail: A great example of highly regulated retail is pharmaceuticals. Amazon entered this space when it bought PillPack, an online pharmacy that organizes your pills. But its upside is constrained by the highly regulated pharmaceutical delivery market. The licenses Amazon grabbed from its PillPack acquisition apply only to mail delivery. Meanwhile, our First Stage Investor company offers a free same-day delivery service and a one-hour service for a small fee.

In order to compete with this startup, Amazon would have to build a more expansive delivery infrastructure from scratch, including getting the right licenses. Amazon also can’t turn to two of its favorite tactics: undercutting prices (because they’re determined by third-party payers) and offering the widest selection (whatever drug is requested, our competing company can easily procure it from its supplier).

Highly specialized retail: Schick bought shaving startup Harry’s for $1.37 billion. Eyeglass company Warby Parker is worth $1.2 billion. And shoe retailer Zappos made $635 million a year before Amazon scooped it up for about $900 million. Amazon, with its massive and often generic shopping selection, has had trouble competing against these types of highly specialized, online, direct-to-consumer retailers.

When I’m considering investing in e-commerce startups, I ask founders two questions: How do you compete against Amazon? And how do you avoid competing against Amazon? And when the startups are in the three retail categories above, I expect, and often get, convincing answers.

Amazon may be big and powerful, but it does have some chinks in its armor. At a time when e-commerce is growing rapidly, tiny startups are making waves and jumping in where Amazon’s power to squash the competition is diminished.

Good investing,

Andy Gordon

Co-Founder, Early Investing

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How Many Startup Investments Are Enough?

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