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Why boards aren't in the business of 'delivering happiness' to all, but IRR to limited partners
"Did you know that people are very bad at predicting what will make them happy?" asked Amazon CEO Jeff Bezos during an hourlong meeting with Zappos CEO Tony Hsieh, prior to both sides agreeing to the sale of Zappos to Amazon for some $1 billion last year.
Jeff and Sequoia Capital partners seem to have one thing in common: They both know that people are terrible at knowing what will make them happy.
So, why not just focus on a small group who matter and have a clear vision of what makes them happy?
That appears to be the case with Zappos and its investors at Sequoia Capital.
Sequoia Capital, which invested $48 million in the online shoe retailer, prefered to focus less on customer happiness and more on a company's bottom line, despite the fact that profits too can be unpredictable.
This is all revealed in Tony Hsieh's book Delivering Happiness, and a recent article penned by Tony for Inc., titled, "Why I sold Zappos."
As Tony puts it, he would have rather focused on the customer and the culture and one day go public. But the board, made up of "primarily technology and manufacturing backgrounds, not retail or branding," wanted "us to focus on the financial performance that were being driven by our e-commerce business."
Sequoia Capital had first invested in 2005, and the five-year mark was fast approaching, Tony wrote in his book. Tony, Alfred Lin (Zappos CFO), and Fred, Zappos co-founder, didn't want to sell the company but Sequoia pushed for a return.
"The board wanted a financial exit, but internally at Zappos we didn't want to exit. We wanted to continue to build, and we were in this for the long haul," wrote Tony.
From the article: Although I'd financed much of Zappos myself during its early days, we'd eventually raised tens of millions of dollars from outside investors, including $48 million from Sequoia Capital, a Silicon Valley venture capital firm. As with all VCs, Sequoia expected a substantial return on its investment -- most likely through an IPO. It might have been happy to wait a few more years if the economy had been thriving, but the recession and the credit crisis had put Zappos -- and our investors -- in a very precarious position.
At the time, Zappos relied on a revolving line of credit of $100 million to buy inventory. But our lending agreements required us to hit projected revenue and profitability targets each month. If we missed our numbers even by a small amount, the banks had the right to walk away from the loans, creating a possible cash-flow crisis that might theoretically bankrupt us. In early 2009, there weren't a lot of banks eager to give out $100 million to a business in our situation.
That wasn't our only potential cash-flow problem. Our line of credit was "asset backed," meaning that we could borrow between 50 percent and 60 percent of the value of our inventory. But the value of our inventory wasn't based on what we'd paid. It was based on the amount of money we could reasonably collect if the company were liquidated. As the economy deteriorated, the appraised value of our inventory began to fall, which meant that even if we hit our numbers, we might eventually find ourselves without enough cash to buy inventory.
The company initially considered buying out the board of directors with some $200 million. The three men even started seeking investors for this buyout. Then Amazon came calling in early 2009, four years after Jeff Bezos first contacted Zappos in 2005, when gross merchandise sales were $350 million.
"We had originially been resistant to the idea of exploring the an acquisition scenario with Amazon, but Michael Moritz convinced us that it could end up being mutually beneficial and the best possible outcome for shareholders as well as employees."
While Tony has spent a lot of time sharing his thoughts on building a company culture (See Tony's standing-ovation speech), the article as well as the end of his book, do shed light on the realities of having different goals than a corporate board and venture investors, whose main goal 99% of the time is not delivering happiness to all, but an internal rate of return to a limited few.
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Our goal is to position Zappos as the online service leader. If we can get customers to associate the Zappos.com brand with the absolute best service, then we can expand into other product categories beyond shoes. And, we're doing just that.
Internally, we have a saying: We are a service company that happens to sell ________.
- and handbags
- and clothing
- and eyewear
- and watches
- and accessories
- (and eventually anything and everything)