Transcript: Lessons in Reinvention and How to Make a Successful Pivot (Paddle8, Osman Khan)

Laurel: Hi everyone, my name is Laurel Touby, and welcome to our inaugurate Series A podcast. I run a group in New York City called Flatiron Investors. We make seed-stage investments in mostly B2B companies that are disrupting industries from FinTech to virtual reality. Before this, I founded and ran that company for ten-plus years before selling it a few years back.

For the Series A podcast we interview founders who've surpassed the most critical juncture of their company lives. Like salmon, they've survived the first calling and are now in the process of swimming upstream and could use an assist with some venture capital.

What does this mean in tech terms? They've achieved traction. And for different types of companies this means different things. For consumer apps it could be 50,000 daily active users and 25 percent month-over-month growth. For e-commerce it could be a million in monthly recurring revenue. For SAS it could be 1.5 million in annual recurring revenue. In any case, they've got traction, and our goal is to speak with founders who've gone through their Series A rounds and learned from their experiences. After all, there's no better mentor than someone who's been there before you.

Paddle8 was founded in 2011 as an art gallery marketplace where galleries could sell art online. They worked with 440 galleries from around the world at their peak and had great word-of-mouth. But while the company was a critical success it was not a financial one. The CEO faced a choice; die a slow death or pivot.

Founder Osman Khan made the hard choice to rip out his early team and pivot. And it was a good choice that he made because last year Paddle8 had 35 million in sales, up a 146 percent from 2013. And for the first half of 2015 they achieved 25 million in sales. I'm happy to report they just raised their Series C round. So without further ado, let's dive into the conversation with Osman to learn the details behind the pivot that propelled Paddle8 to where they are today. Shall we call it the big pivot or...

Osman: We should. It was a rather large pivot for us.

Laurel: So really, the best practice that you're gonna talk about today is how to know when something is not working, how to know when to change, and how quickly to change.

Osman: Sure.

Laurel: Let's talk a little bit about just the company overall. What does it do for people who are new to Paddle8, what did it do originally, and then we'll go into figuring out that something was not working.

Osman: Great. So Paddle8 we launched in 2011. Today it is one of the leading online auction houses for art design and collectibles. And really, the value proposition from a layperson's perspective is we want to be the next luxury eBay. So we try to fill the white space where eBay stops to offering trust and taste and the larger auction houses can't really fulfill sort of the demand at the lower price points.

And so somewhere between 500 dollars and 25,000 dollars you have all this volume that's largely unaccessible and unsurfaced. And so we want to become the go-to place for everything where you might find a great print, to the next best album from the Wu-Tang Clan, and sort of everything in between. And that's what we are today.

But when we launched in 2011 we were a completely different company. And so, in fact, it was more meant as a gallery marketplace. So galleries would list all their work. The value proposition that we would offer them is being able to connect them with potential buyers and we would take a commission in between.

Laurel: And you were pretty successful at that, right?

Osman: We were. We had some great traction. At the peak in 2011, we worked with 440 galleries around the world. We were the first people to sort of leverage the online art fair model. We work with 14 of the sort of leading art fairs in the world. We had great credibility. We had credible traction with sort of collectors. It just wasn't a sustainable revenue model.

We found just a lot of challenges in completing sales. And so at the end of 2011 we had this classic decision point between we had incredible engagement, we had a lot of people on the site, but no one was buying anything.

Laurel: So you had traction.

Osman: Yeah.

Laurel: You had people who were really invested in that business model, correct?

Osman: That's right. Exactly.

Laurel: Who were those stakeholders who were invested in the business model?

Osman: I think this was the crux of it. The people who were invested were the people who were, as we call them, the insiders. They were the gallery owners. They were people in our staff who came from the art world. One of our three investors at the time who was an art world person themselves, he actually owned a gallery.

And so as we sort of stepped back and looked at it, everyone who thought the model was great were people who were from inside the industry. And then myself and my two co-founders, who didn't come from the art world, were actually completely opposed to it. It just didn't make sense to us fundamentally what we set out to do and where we were relative to how the market was transacting. And so implicitly, in our gut, something didn't feel right.

Laurel: So the voices though around you were all clamoring and saying you gotta stick with it.

Osman: Yes.

Laurel: And how much longer did they think you had to stick with it, and what were their arguments when they were saying that?

Osman: I think their arguments were, and again, they said if you play the engagement game long enough you will find a way to monetize that. So I think there is this conventional wisdom in sort of venture capital land, or sort of as entrepreneurs believe, that if you have enough people on a site following you, engaging, looking at something, you might eventually convert them into buying something.

And I think we had come from the view of the world that there's no better company than one that makes money today, and if we're making money today we will be infinitely better off in the future. And so finding a profitable revenue model was more important to us period, full stop. There was any number of other things we could figure out along the way, but if that didn't exist, it didn't feel like a scalable entity to us.

Laurel: So at the time you had some engagement, but did you have any revenues at all?

Osman: Very little. It was a very choppy business. We probably had less than a million dollars in sales that first year. Very concentrated. So an absolute number of transactions was probably single digits. It just was really high price inventory and it just didn't seem compelling. It didn't make sense for us.

Laurel: And you had investors at the time, correct?

Osman: We did. I mean, we had raised 1.5 million dollars of sort of whatever you want to call it, angel, friends, family, early investment money. We didn't have institutional investors. We then raised institutional funding in 2012 basically on the back of our pivot.

And so when we started the conversation with the institutional investors it was telling them about what we were doing today. And as we saw this conversation play out, we were like something here is not gonna add up. And so we stopped, repivoted, and then went out to the market again. And the story that we told the second time around, as this auction house that was going to really fulfill all the white space that we defined it as, seemed to resonate a lot more and it made a lot of sense.

You saw the auction houses moving further and further up market. You saw eBay really being unable to fulfill the luxury collectible space because it's fraudulent. People don't wanna buy on eBay. Sellers hate fulfilling on eBay. Et cetera, et cetera. And it just seemed like a really clear value proposition for us.

Laurel: How did you come to the decision point, the one moment when you realized, oh my god, this is what I have to do, I see a path?

Osman: So I think we've always believed in you can go with gut, but there's also calculated gambles. And what we did is we launched a series of five test auctions at the end of 2011 to validate at least that the auction model, assuming we had the right inventory, would be successful. And each of those five auctions had an 80 percent sell-through rate. So 80 percent of what we offered sold out.

So I think on the base of that we saw a data point that said look, we may not have it a hundred percent figured out, but at least the model as we've defined it, we find the right property, you package it well, and you have a buying audience, there is a model here that's going to work. Now on the back of that, we basically repivoted the whole company. So we took the calculated risk of sort of understanding what the proof of concept would be. And then on the back of that were very, very expedient, in how we sort of pivoted to the new model.

Laurel: So what were the steps you took to pivot to the new model? You did the test. And these were things that other founders can do, right?

Osman: Absolutely.

Laurel: You've had a gut that it wasn't working, right?

Osman: Completely. So I think step one is acting on your gut reaction sooner rather than later. So you know something doesn't implicitly feel right, it is always easier to sort of keep that feeling down, and as I like to call it, kick the can down the road. But I think acting on that gut reaction sooner rather than later is imperative.

Laurel: Where were you getting that gut reaction? Because you were surrounded by people who were invested in the old model. So where was your gut coming from?

Osman: The gut was coming from the fact that we weren't making money. And I think we believe that in an age where we know that this is – we're gonna have to raise more money down the road. We probably need scale at some point. There's growth considerations. If we wanna be a company that's going to be successful in the venture capital raising market we need a true revenue model, and this model did not seem to get us to that point.

And so, for us, it was if this isn't the right part of the market in which to play. So this was the defined as the primary market, the galleries. Perhaps a secondary market, which is auctions, because that is a mode people are familiar with. We all know about the auction houses. We know about eBay. We're familiar with it. Perhaps there was a better, almost mousetrap, to create in the auction market, and we could be the front-end for that before anyone else got to it.

Laurel: Were there already players in that market though?

Osman: No, absolutely not. That was the best thing. I think for us, first mover advantage was exactly one of our biggest advantages. Because again, you had traditional brick and mortar, and then you had eBay, but no one else was really thinking about it. And to be honest, at the time, people were still asking us the question, will art sell online? Will people buy online?

It wasn't even about primary versus secondary. It was a more fundamental question of will people transact in these price points for what you're selling online. And so, for us, that proof of concept was even more important. Because we did five auctions. We were able to sell inventory between a thousand dollars and 25,000 dollars site unseen in an auction construct. Because what you find, and sort of over the course of now a thousand plus auctions we've proven this, when people buy in an auction they're larger people who know what they're looking for.

And so if I'm buying a specific print, or I'm buying a specific edition, or if I'm a collector of wine, I know what wine I'm looking for. If I'm a collector of rock memorabilia, like, you have a discreet purpose for what you are coming to Paddle8. As opposed to in the model we used to have, it was very much about someone just browsing and engaging and not really every wanting to transact necessarily.

Laurel: So the first step is acting on your gut and taking action, right?

Osman: Correct.

Laurel: And in your case that was just doing a proof of concept?

Osman: That's right. Exactly.

Laurel: And then what's the next step in pivoting?

Osman: I think the next step is about really the internal and external communications that need to happen. So for us, internally, it was very much about you're making those hard decisions about the team that we had to, to be quite honest, be left with, versus making the hard decision of letting some people go, but being very clear as to why we're moving this way so that it didn't seem confusing to anyone internally.

And then second, most importantly, because of this great brand credibility we created with the galleries and the art fairs, it was very important to send a united message as to why we were moving this way, and how in the new world of Paddle8 those constituents could still be part of our ecosystem. So what's really funny is we used to have galleries who would operate as sort of listing dealers on Paddle8 who now became consignors to our auctions.

And so, in that transition, we found a way to maintain the same stakeholders, but have them play sort of, or operate, with Paddle8 in a very different capacity. And by allowing them to have that sort of a little bit more of a seamless transition, as opposed to just ending the relationship entirely, we were able to maintain a lot of that sort of goodwill that we have built with these clients over the last two years without sort of saying hey, we're not doing this anymore and we won't talk to you.

Laurel: How did you figure out how to do these internal and external communications? Did you hire a PR firm? What did you do?

Osman: No. It was the byproduct of a lot of conversations with advisers, investors. I don't think we had, and I know for a fact at the time, we didn't have a PR firm. We didn't have the liberty of sort of hiring someone mainly because of cash constraints.

And so I think we had some really great people on our team who we were able to leverage to provide the right messaging for us. But honestly, more than anything else, it came down upon the founders. And so owing up to what you've done right, owning up to what you've done wrong, having the hard decision with your team internally, talking to your investors.

And more importantly, I would say over the course of that six months, we probably personally met with almost half the galleries that we work with to sort of communicate this message in person to really maintain those relationships. And you fast forward four years, some of those galleries now, some of those early partners, are some of our biggest both buyers and sellers in the platform today because they've maintained that relationship with us throughout this transition.

Laurel: OK. So when you said you had to transition some stuff out, those were the insiders, correct?

Osman: Correct.

Laurel: Who were kind of stuck on the old model and really believed in the old model. Why didn't you just keep them and tell them to change?

Osman: I think that's hard. That's trying to fit sort of the classic round peg in a square hole. I think as we move the model we needed people who's thinking would shift with us, largely because we don't have all the answers, right? I think we knew where we were going, but we needed more people who understood the e-commerce auction landscape.

And I think, again, as you think about the classic considerations around burn, and runway, and how much time do you have something to figure out, you want the right people to help give you the right opinions and decisions rather than having to force-fit someone else's mentality into a model they don't think is going to work necessarily.

Laurel: Was that the hardest decision, was letting go loyal, wonderful people who started with the company?

Osman: Absolutely. Completely.

Laurel: That must have been so hard.

Osman: It was gut wrenching. Because I think, as all founders go through it, loyalty is really important. And the people who sort of came through the wall with you in the beginning are the ones you want to have around in the end. And I think it's an unfortunate part of that pivot. It just doesn't work out that way.

So the people who were there for the first year and a half rounded out with us, took pay cuts. It was the hardest part because they wanted to be a part of whatever legacy we were gonna create and the jobs just weren't there. So, absolutely, that was the hardest part of it all.

Laurel: Yeah. Is there any other step to the pivot?

Osman: I think those are the three big things.

Laurel: What was the third thing?

Osman: I break it down to three. It's understanding what's working and not working, and trusting your gut, step one. Step two is actually having some proof to validate your pivot or that your reaction to what you're thinking is right. Then step three, and this is I think – step three is the idea of the internal restructuring, external communication, is doing that as quickly as possible. Right?

And so it's very easy to, as you just eluded to, potentially trying to force-fit existing hires to a future model, or saying look, we don't really need to communicate with the stakeholders just yet. But the quicker you do those three things I think the faster this process becomes. And then step four was more, for us, repackaging everything we had and then taking it back to the capital markets to raise our next round of capital. And I do believe it was immensely successful. Sort of, the model, has played out really well over the next four years after that.

Laurel: Let's go back a little bit to the capital raises.

Osman: Sure.

Laurel: Tell us more about the raise after that. Did it get easier after you pivoted?

Osman: It did tremendously. So the first round of capital we raised in 2012 was from two investors. Founder Collective, based in Boston, they're early stage investors in a lot of successful companies. And Mousse Partners, which again, is the family office for a large luxury family, active and added sort of follow-on investors for us.

I think it sort of funny as we've been talking, and I've been thinking about what else we might have done right, and I think it sort of has worked out if you connect, hindsight being 20/20, having someone like Mousse who is a follow-on loyal investor has served us tremendously well. I think they understand the auction space really well. They themselves take a view of life cycle investors in whatever company they invest in and that's been really really helpful for us.

Now, I think it's really hard to sort of say that when you are strapped for cash and you're looking for venture capital. But I think there is a lot to be said about investor entrepreneur fit. And to the extent that you have the luxury and the ability to find that, the right chemistry can go a long way. And if you look at every subsequent round we've done, and our rounds fortunately have gotten larger and larger, Mousse has been an active investor throughout our life cycle. And the most recent round we're about to close, they will continue to be one of the largest investors in our cap table.

Laurel: Let's talk a little bit investor entrepreneur fit. Because so many entrepreneurs just want money.

Osman: Sure.

Laurel: And they walk into these meetings and they meet with investors and all of them look the same. How do you know that this person you're talking to across the table that you're gonna be desperate to talk to when things are bad? How do you know that they're really gonna be there for you?

Osman: I think you hit it on the mark. The best way to assess that is to talk to companies that they've invested in where either things didn't go right or times where tough where they had a down round, or even honestly, if the company failed, why did it fail, and what was that investors reaction in that outcome? And we absolutely did those diligent checks on our own end.

Laurel: Didn't that take extra time and effort?

Osman: You know, it does. But it's a worthwhile exercise, right? And I think that's exactly the way to think about it. You know, when the markets are sort of quote unquote frothy and valuations are great, a rising tide lifts all boats, right? And so it's very easy for entrepreneurs to be able to, and it's a great thing, to optimize for the best valuation and just take cash.

I think it's when things go sideways, or when the markets aren't in your favor, or where your business model is not working out, where you're put to the test as to what the value of your investors are. And the investor that supports you through sort of thick and thin, that's really who you want at the end of the day.

Because I think this is a very unpredictable road at its core. And you never know where you're gonna end up, whether you're gonna have to have two pivots or –  where the markets completely go sideways and you're stuck out without a true fund raising environment. And someone who's willing to cut you a check because they believe in you as the team is a very, very powerful thing.

Laurel: Now that you've done a lot of fund raising and you've learned a lot, what's the best question you could ask a potential new investor?

Osman: That's a great question. I believe the best question to ask is do they believe that the role of them as an investor in the board is to support the founders or to drive the vision of the company. And it seems like a very subtle difference, but it actually ends up being materially different in how the board and the founders interact.

I have found that when you ask that question you will find that it's a big reflection of the investors' overall investment approach and thesis. And there are lots of investors who believe that the board is setup to help control the company, as opposed to there are a lot of investors who believe the board is there to just support the founders and it's the founders who should e creating the value of the company.

It's a transparent world. It's very easy for us to pick up the phone and find out, in the age of CrunchBase and AngelList, and everything else, what other companies they've invested in. And it's a small network, especially in New York, to find five other people they've invested in and ask them what those founders view of the world is.

And to be honest, we've done that. And we've found a full range of answers when you sort of have a heart to heart with another founder who's been through the trenches, so to speak, just like you have. So yeah, it is funny. Sometimes you ask that question and you will get the answer that everyone says oh we're here to support the founders. But just like they do diligence checks on us, it's very easy to do diligence checks on them as well.

Laurel: What are some other ways that you've learned to ask for help from your investors? So many times entrepreneurs get investment and the VC or the angel, or whoever is putting in money, promises to help and then they don't. It's incumbent upon the CEO to ask for that help.

Osman: It absolutely is. I have found the most successful asks for help have been the ones that are the most precise. So I think we all get caught up in asking for a really high level of guidance. I need help recruiting. I need an introduction to x, y, or z. Or, do you know investor X? I find that those are just really easy questions to overlook. But the more specific you are in what you really need, concretely, to grow your business, I think the more receptivity I've gotten.

So we are looking to expand into China and need to find a very specific partner who can help us think about shipping and logistics in China. That is a very concrete request that produces – and it's usually a very binary outcome. Either they say look, we just don't know that world, we can help you find it, or it results in a very direct answer with a very specific outcome. I find the more open-ended the requests are the less you get out of your investors because it just seems like another request similar to anything else you've asked them.

Laurel: When you do those requests do you send them by email or do you make a phone call?

Osman: Phone call. I think email is not as efficient as it used to be. And especially, any investor will tell you they're probably inundated all day long with emails. So we try to make it a point, I think we're very fortunate, and obviously I think this works differently with different investors, but we found it always very helpful five minutes on a phone call is infinitely more useful and effective than 50 emails back and forth.

Laurel: In terms of communicating with your investors, obviously you're very good at communication. You've articulated that when you were making your pivot you communicated internally and externally. How do you communicate with your investors that you think is something that you could share with other founders?

Osman: I think over communication will always serve you better. As entrepreneurs and founders, we're obviously encumbered in trying to get our businesses working. We have a myriad of issues that we're dealing with every single day. But I think if you find an hour out of your schedule once a month to send an update it goes a tremendously long way for your investor for a number of reasons.

I think first and foremost it's just a sanity check and a pulse that they know that one of their investments is still alive and running. I think, secondly, and most importantly, it saves you a lot of heartache and headache either when things are going right or when things are going wrong, and most importantly when things go wrong.

Because investors don't like surprises. And so if you tell them month to month that either you are on track or things are going as well, when you get to that board meeting or when you get to that critical juncture it's not a surprise. You have pointed to them and said listen, we saw early warnings, early signs that this is happening, and sort of thesis that we eluded to six months ago is now playing out, so lets make a proactive decision.

As opposed to if you don't give them those updates, and then you go to your quarterly board meeting or semi-annual board meeting and drop a big red flag, not only are you handicapping your ability to make some concrete decisions, but you play a lot of time in catchup. Why did this happen? How did this happen? And then it obviously results in natural questions, why didn't you guys do anything sooner? And you spend more time iterating on the problem...

Laurel: Defending yourself.

Osman: Defending yourself and on the nature of the problems as opposed to coming up with a solution. And so I think it's really helpful to frequently communicate.

Laurel: But isn't it scary if something is going wrong, or you're not sure it's really going wrong, or you want more data on it before you kind of alert somebody, isn't it scary to tell people news that they might not wanna hear?

Osman: I think the devil is in the details. I think every successful entrepreneur, every investor will tell you this as well, you always know what are the metrics for how you judge your company. So whether it's KPI's, or user base, or growth, or revenues, whatever the ten things that are important to you that you measure month to month, week to week, year to year, those are what you share with your board, plus/minus any other key updates.

And so I think the way to think about it is it's not about necessarily sharing any huge red flags by email, it's more saying which way our are metrics trending. And so again, the periodic update month by month helps you create trends or see trends sooner rather than later that can then result in a much more informed conversation.

I definitely wouldn't advise mentioning just by email that you've lost your biggest client. I think that's more better done in person. But I think it's more about just giving them an idea of how the business is doing overall. Because invariably they have seen these things multiple times over than you as a founder have, and so with their line of sight they can sort of read between the lines and help you come to decisions a little bit faster than you might realize.

Laurel: Last question. So you've just announced that you've raised your Series C?

Osman: We have. We're really, really excited. Yeah, it's a huge, huge thing for us.

Laurel: Huge congrats Osman.

Osman: Thank you

Laurel: Huge congrats. Anything you want to share about this exciting news?

Osman: Absolutely. It's 34 million dollars Series C. I think the most exciting thing for us is having David Zwirner. He's one of the largest dealers, super dealer as they call him, in the art market, in the world right now. He has taken a very active position in the company. He's going to be joining our board.

I think, for us, it's not only a validation that this model works, but that some of the most active stakeholders in this industry are taking us seriously. And to have his validation is tremendous for us. So I think that's probably the biggest part of this for us.

And then, as I mentioned earlier, Mousse has followed-on in the round, which is again a great validation that they continue to believe in us, which is great. But we're super excited. The capital is largely – it's sort of a classic growth round, really thinking about improvements in technology, operational scaling, predominately in Europe. And then a lot of it is focused on finding the best talent from a sales perspective to help us source all the great things that we're selling on Paddle8 and more.

Laurel: This is so exciting.

Osman: Thank you.

Laurel: I'm so thrilled that you came on the show today. What is your one ask that you wanna ask the audience that you need help with? China, maybe?

Osman: China. That's absolutely right. We, every day, are told that we need to be in China. Chinese market is a tremendous opportunity from a buying and a selling perspective. So if anyone out there knows the right partners that can help us expand, please do let us know at Paddle8.

Laurel: Fabulous.