Wealthfront raises a cool $20 million from VCs to pursue a big slice of a $1 trillion market

The Palo Alto fast-grower brought aboard a LinkedIn veteran who played a role in the 20-million- to 200-million-member jump; a VC tells how he 'leaned forward in his chair'

Friday 3.22.13 by Kelly O'Mara

Brooke’s Note: This is a cool article by Kelly O’Mara. First I’ll credit Andy Rachleff (who may have a bit of a journalist’s soul; he’s written a couple of good columns for us) for doing a lively interview where he made an irreverent comment or two about human financial advisors knowing full well that he’s speaking to a publication whose readers almost universally value human financial advisors. (To be fair, Andy has a few human advisor types but most are engineers.) He also could — to keep the heat of expectation low — played it coy about his company’s ambitions. He didn’t. Andy is thinking and talking growth in hundreds of billions in assets. Even Schwab and Fidelity don’t talk that way — and Andy knows that. He also gave a detailed enough description of his business plan that the logic of how it miiiiggghhht work is there. A final note: Kelly also interviewed a real-live customer of Wealthfront, who is also a writer for TechCrunch who wrote a cool article of his own on this subject that is linked below.

Internet-based advisory platform Wealthfront announced Wednesday it has secured $20 million in venture capital from three firms, led by Index Ventures, as well as the Social+Capital Partnership and Greylock Partners, and from a number of individual investors.

Palo Alto, Calif.-based Wealthfront allows investors to put anything over $5,000 into an online diversified portfolio-based on their risk assessment — and for minimal fees.

With 70% growth in the first three months of the year bringing Wealthfront to $170 million in assets, it’s easy to see why the Silicon Valley-based backers’ ears perked up when the financial tech company came a-calling.

In a blog post this week explaining Index Ventures’ decision to invest, partner Mike Volpi explained that Wealthfront’s recent 30%-per-month growth attracted his attention. When he heard about the company’s growth, he wrote, “I quickly leaned forward in my chair.”

A trillion here…

Both Volpi and Reid Hoffman, of Greylock Partners, in his own blog post this week, cited the company’s recent high growth and the potential $13 trillion in non-institutional, non-401(k) assets as reasons their respective VCs decided to back Wealthfront.

Andy Rachleff, chief executive and co-founder of Wealthfront, says that his company’s not going after that whole $13 trillion, but maybe it could target $1 trillion of the marketplace, which is still plenty.

“We’re trying to build a business that attracts tens of billions or hundreds of billions of dollars,” he says in an interview with RIA Biz. “Our investors think we have a really good chance.”

Spending $20 million

The X-factor is if there’s anything to suggest that Wealthfront can continue to grow at a rate that will enable it to hit those high marks. Rachleff believes there is. He argues that it’s hard for traditional advisors to wrap their heads around why someone would want to invest $20 million in an internet start-up RIA, particularly one that is “nowhere near profitable,” according to him.

But that’s because traditional advisors are hoping to get, at best, a few hundred million in assets. That’s not what Wealthfront is doing. By making a high-end management tool available to everyone, with a minimum of $5,000, Wealthfront’s pool of potential clients is far larger and its costs far lower. The first $10,000 assets on the platform are free and after that it charges 25 basis points.

This capital will pay for an increase in expenses, Rachleff acknowledges, even though the company isn’t profitable, in order to “go after that opportunity.”

Less DIY, more delegation

For the last year and a half, since pivoting from an initial strategy that had the company bringing together money managers online, Wealthfront has been developing the investment management tools for its new strategy of providing complete wealth management through its website. That original plan was a bust, because it failed to attract interest from consumers, but it led Rachleff to this model: less DIY and more delegation. See: Looking more like Windhaven after a revamp, Wealthfront names a noted academic CIO and boosts its assets 15-fold.

Wealthfront originally raised about $10.5 million from angel investors and DAG Ventures in 2008. Now, says Rachleff, it’ll use the new $20 million capital to continue to add investment features, but, more importantly, to grow — just don’t call it marketing. See: Looking more like Windhaven after a revamp, Wealthfront names a noted academic CIO and boosts its assets 15-fold.

Sharing technology

In internet-based companies, Rachleff says, “growth is a function of features you add to make people share it.” That means ways to invite friends easily, send a link or an e-mail, and share online. But, $20 million will buy a lot more than a Facebook “share” button. The company recently hired a new vice president of product and growth, Elliot Shmukler, who was the senior director of product at LinkedIn, where similar tech-based growth strategies — think of all the ways you’re encouraged to invite people and add friends to your LinkedIn profile — increased the company’a membership from 20 million to 200 million. See: Advisor Tested: How LinkedIn can truly build your business and not just feed your ego.

Wealthfront also hired, recently, a vice president of engineering, Avery Moon, who was the senior director of engineering at LinkedIn. And, as they expand features, such as diversifying the fixed income allocation, they’ll hire more engineers to write the code. The company currently has 22 employees, the majority of whom are engineers

“Advisors are of no value” to younger investors, says Rachleff. Wealthfront relies on about five knowledgeable Ph.D.s and advisors, such as Burton Malkiel, to direct the investment configurations based on modern portfolio theory. The rest is just math. “You need to recruit a few experts to inform,” Rachleff says, and then you hire engineers to carry out those instructions. “You don’t need to hire more experts.”

The ties that fund

It’s a philosophy that has rung true in Silicon Valley, where there’s an app for everything. And, it’s no coincidence that 70% of Wealthfront’s customers are young and in tech fields. See: Can Silicon Valley rewire the RIA business? eBay investors think KaChing is the answer.

One Wealthfront customer, who also happens to be an editor at the popular site TechCrunch, wrote an article espousing his belief in the service. Eric Eldon wrote that after he opted to invest his startup earnings post-acquisition into Wealthfront, “I began making money from it immediately.” He says he achieved just over 4% and 5% respectively in his low- and high-risk allocations.

Eldon, who epitomizes the young, tech-centric entrepreneur the RIA is going after, says he started trying Wealthfront in November 2012, when it made the transfer process simple and easy. He came to the site after looking at other advisors, with whom he was unimpressed.

“I talked to some financial advisors, who recommended various packages that promised uninteresting returns, along with fees that looked to zero out any of those gains. I sat on the problem for months, unsure of what to do,” wrote Eldon.

Rachleff says the company deliberately targeted Silicon Valley because that market would be filled with early adopters, he said. The fact that it also happens to be where the venture capital funding and engineering talent and tech connections are was a beneficial coincidence. It’s an approach that is also bearing fruit for some conventional RIAs. See: A $17-billion RIA doubles down on a social media strategy that netted it 50 Facebook employees.

“It’s a nice side benefit,” says Rachleff.

Widows and military clients

Volpi’s blog post on the VC’s investment actually starts by referring to “our good friend Andy Rachleff.” Hoffman’s post references his relationship with Adam Nash, the current COO of Wealthfront, who previously worked with Hoffman at Greylock Partners as an Executive-in-Residence.

The ties between the Silicon Valley internet RIA’s executive team, its backers, and its customers are many and interconnected. It’s easy to see why the product might catch on quickly in the insular, start-up, tech-focused community. But it’s also easy to see why it might have trouble spreading beyond that sphere — which is the next goal.

Rachleff says, though, that there are “a number of adjacent markets that are ready to be knocked over” based on the fact that even without marketing or outreach 30% of Wealthfront’s clientele aren’t in that 35-and-under technology demographic. The company has elderly widows and lots of military clients, as well.

And, with a Dropbox-like feature that allows clients to invite friends and get $5,000 in assets managed for free, one-third of its new customers come in through the invitation system. Expect more growth initiatives along those lines as it tries to expand outside Northern California. See: Online brokers may be bigger threat to financial advisors than they realize, study says.

What’s the difference?

Certainly, Wealthfront is not the only venture trying to find an Internet-based solution for the mass market. Most recently, Microsoft-connected Motif launched with a plan to bring theme-based trading into the hands of the consumers. See: A Microsoft alum stomps into the RIA business with $26 million in VC money, Sallie Krawcheck and a 'new’ approach that looks old to skeptics.

But, Rachleff says that Motif may appeal more to the to the do-it-yourselfer. What about Betterment — another web-based RIA — that has gotten its fair share of attention? we asked Rachleff. “They’re more like a savings account whereas we are an investment account and that’s supported by average account sizes.”

Betterment’s average customer size is around $4,000, which is lower than Wealthfront’s minimum, he says, while Wealthfront’s average client is around $80,000. “Why would you use Betterment if you have access to us,” says Rachleff. See: After outcry, Betterment 86’s (but not on purpose) a blog post inflaming advisors.

$20 million worth of momentum

Debate about the mass market, tech-driven options can get fierce. Just read this conversation from last year on Quora about the difference between Betterment and Wealthfront. In the online debate, both sides argue extensively for their superiority.

“Betterment is simply better for most investors,” wrote Jonathan Stein, CEO of Betterment. That’s because his firm has no minimums, is more smoothly integrated, and has more customization. “In summary, don’t take my word for it; ask our customers. We’ve got a lot more of them than Wealthfront, and they love us,” he concludes.

Wealthfront, Rachleff believes, will succeed in capturing the most of this hotly fought-after market because people don’t want to do it themselves, they want to delegate, and because Wealthfront provides a higher level of wealth management than those people could otherwise afford. That the company was able to raise this money suggests someone else must believe him too.

The “$20 million is testament to venture capital believing we have a chance to build a really big business,” he says. “The momentum we’re experiencing is a contributing factor.”

The headline of this article was changed slightly to reflect that Wealthfront isn’t pursuing $1 trillion as suggested earlier. It has identified that there is $1 trillion that it considers in its sights. (For Wealthfront to make a suitable return for its investors, it needs about $40 billion of AUM or $100 million of revenue at the .25% that it charges, according to the company.)

Mike Volpi | Reid Hoffman | Elliot Shmukler | Adam Nash | Avery Moon | Jonathan Stein | Eric Elden

Wealthfront | Betterment | Greylock Partners | DAG Ventures