After my short stint on the West Coast, I was determined to pursue something big—something transformational. I was also unemployed, which meant I had a lot of free time.

But coming up with my next big idea felt very pressing. It was the late 1990s and I was 39—already old by Silicon Valley standards, where I had just tried to make a go of it. At that time I didn’t know most entrepreneurs start their first company in their 40s. At the time, I felt like a failure. Selling Merrin Financial was a big disappointment for me. It was not the huge success I had planned for or envisioned, and it certainly wasn’t the payoff I had invested 10 years of my life toward. I knew the truth; I had no choice other than to sell it, and I felt like I had sold out. I was depressed and anxious.

I set up weekly meetings with Eric LeGoff, whom I first met when he was tasked with implementing the order management system (OMS) at Heine Securities and who later joined Merrin Financial. He introduced me to his friend Steve Apkon. Our goal was to brainstorm the next big thing. Steve was renovating the Jacob Burns Film Center in Pleasantville, New York, just north of New York City, and every week we met in one of the desolate offices in the building. Our conversations were all over the place. We had a lot of ideas, but none were very good.

It was more of an exercise. We were flexing our brain muscles, and that work did lead us to ask a lot of questions about what we could do. I had learned some valuable lessons about what not to do in Silicon Valley, so I was pretty fixated on going back to where my skill set and experience was and doing something around making the markets more efficient.

At Merrin Financial I knew I had solved a really big problem, but what I didn’t know at the time was that it also built the infrastructure needed to solve a much bigger problem.

At this time in the financial world, institutionally managed assets had grown almost 40-fold from the start of the bull market in 1981. That’s when the institutional market started. 401(k)s had just been introduced, and there were very few hedge funds. There had previously been very little interest in the market as the annualized return of the Standard & Poor’s (S&P) 500 from 1960 to 1981 was only 1.74 percent (including dividends), yielding an entire generation of uninspired returns. From 1981 to 2000 the annualized returns jumped to 11.79 percent. In 1981 the entire institutionally managed sector was only $240 billion. (Today, it’s $15 trillion.)

As the assets under management grew, so did the size of their orders. This created some issues. Institutional buyers had nowhere to purchase or sell stock in the quantities they needed to. They had to buy their goods from the retail stores (the exchanges), which were not equipped to handle their quantities. Think about the American Old West and the general store that served the community. That’s all the financial industry had—general stores. However, the industry had grown way past the general store. It was as if the industry had all of these new Walmarts, and the only place to source all of Walmart’s goods was the general store. It didn’t work.

The biggest “Walmart” was Fidelity. It managed over $1 trillion—that alone was four times larger than the entire sector was when I started Merrin Financial. Every time Fidelity wanted to buy and sell stock, it moved the market. No surprise. Much as the general store would not be equipped to sell Walmart 6,000 sweaters, the stock exchange was not able to handle the larger order sizes of the growing institutional sector.

The result was that every time these institutions bought and sold stock, they moved the price significantly against them. If an institution wanted to buy a million shares of something, they most likely had to buy it in increments of about a thousand shares. That’s a problem because with every thousand shares, the price moved. The result was that Fidelity, or any large institution, would force the price up, and the more the price moved, the greater the impact was on the returns of all of the individuals who invested their money with that asset manager. That hit wasn’t small. In 2001, it was estimated to be over $100 billion a year. It was certainly enough of a problem that, if solved, would be a huge benefit to a lot of people around the world.

Everybody knew about the problem. In fact, a whole industry was created, known as Transaction Cost Analysis, which was built around this problem. It wasn’t about solving the problem. The purpose of that industry was only to measure how much these companies moved the stock every time they traded. People paid a lot of money to measure how much they moved the market—not to do anything to solve it. This was my big WTF that inspired my next opportunity. While we would not be the first to try to solve this problem, the industry for the most part just considered this a cost of doing business. But what if there were another way? I asked myself: How can we create a wholesale market for these institutions? How can we build a critical mass of liquidity in a short enough period of time to keep people’s interest and be successful? How can we stop the market moving against these firms and get them a better execution? What are the one, two, or three things that if we solved, we would have an unfair competitive advantage?

Then, in the middle of the night, while I was away for the weekend in my country house, sleepless and surrounded by the sound of crickets, the solution started to come to me. My biggest entrepreneurial epiphany struck. In an instant I understood how to create a critical mass of institutional liquidity off the exchange—enough liquidity to create an institutional wholesale market. The OMS! It contained everything the institutions wanted to buy and sell. All we had to do was seamlessly integrate into the different OMS systems, convince the asset managers to allow their orders to flow into this new system, and have their liquidity form a new institutional market.

It was simple—so simple, in fact, that I scribbled the mechanics of the idea on a piece of my kids’ drawing paper.

The next day, I called Eric LeGoff. “You’ve got to come into the city,” I said.

He came in to meet me, and I didn’t say a word. I just showed him the drawing. “Look at this,” I said.

“That’s it,” he replied.

The idea for Liquidnet was born. It was simple. But that didn’t mean it would be easy.

Learn from Others’ Failures

Lots of companies had seen this problem and tried to solve it. Morgan Stanley and Fidelity had tried to solve the problem. There was the Arizona Stock Exchange, which wasn’t really in Arizona but had received some funding from the state of Arizona. There were others as well, and then there was the granddaddy of them all, Optimark.

Optimark was founded in 1996, three years before I came up with my idea for Liquidnet. It raised $400 million of capital. Every major bank had invested in Optimark because this was going to be the solution to the enormous problem with institutional trading. The company was valued at a billion dollars, and that was before it had any revenue. (Can you see where this is going?)

It took Optimark four years to develop its software. It had a huge team (more people prior to launch than Liquidnet has globally today). No cost was spared, and everyone assumed since smart money was invested in this company, it was definitely going to work. There was a lot of hype around the launch, and the company received a massive amount of press.

But the concept was complicated. The Optimark software would ask traders to enter a range of orders and prices (e.g., At this price I would buy a million shares . . . at this price plus $0.10, I would buy half a million shares . . . at this price, plus $0.10, I would buy 250,000 shares.) The idea was that having traders put in that range of prices and specifying what they would buy and sell at those prices would enable them to find the best “clearing” price, and they would execute in size.

There were a couple of fundamental flaws in their plan. The first was that that was not how traders traded. Optimark’s success was based on building a critical mass of liquidity while changing the way traders trade. Maybe that’s possible, but that takes time. What Optimark didn’t understand is that you cannot change behavior and build a liquidity pool from zero to critical mass in a short enough period of time to keep people interested.

The result? Optimark had some traders entering these ranges for their orders but not enough to get to a critical mass of liquidity, so even those Optimark enthusiasts couldn’t find a match. After a bit of time, if they didn’t get an execution on the trade, they stopped trying.

There were other lessons to be learned as well. The system was far too complicated. In order to understand how to use the system, Optimark held a two-day training program called the Optimark Institute. Traders generally have a very short attention span. Traders sat through this two-day seminar, and then almost as soon as they left the class, they forgot everything they learned. By the time the company completed these training classes across the country, the early people who were trained not only forgot everything that they had learned, but many didn’t even remember the password to get into the system.

The product was complicated to use. It required traders to change the way they had always traded, and it was not designed to be a seamless part of their everyday workflow. If traders did use it, for the most part it was an annoyance as they did the work but got no executions, no reward. That meant that traders very quickly stopped using the service. Optimark was four years in the making, and it took just one month to fail.

I took everything I learned in Silicon Valley and for the most part aimed to do the opposite of what Optimark had done. The good news was that Optimark had already educated the market extremely well about the problems it was aiming to fix. (We’d seen how hard that was with Merrin Financial.) The bad news was that it was a spectacular failure—it was the dot-com implosion in our industry—and it left a lot of people and firms feeling burned.

A massive number of firms in the industry had invested in Optimark. Many of our future prospects had put their reputations on the line with their technology teams and the heads of their firms because they all had to ante up resources to work with and integrate this new service onto their desks. And it ended in disaster.

Optimark launched its platform a few months before I started pitching Liquidnet and it had already failed. Very few people wanted to hear another pitch to solve the same problem. But I had a new idea with a different solution to the problem—one that I had only because of Merrin Financial. The big breakthrough I was solving for was the same problem that doomed all the previous attempts and in fact all the business-to-business (B2B) marketplaces of the late 1990s: a way to create a critical mass of liquidity on day one.

The OMS already contained everything that firms wished to buy and sell, so all the liquidity that we needed was out there in a system that I had developed. I had the answer to this big problem because I created the OMS. This was the single most important ingredient to building a critical mass of liquidity. If we could design the interface in a way that required minimal to no intervention from the trader, this would be our unique selling proposition (USP). If we could eliminate the information leakage and match size with size, we could eliminate the price movements and provide a unique and much better execution than they could get elsewhere. That would be our unfair competitive advantage and what we would tout to differentiate it and sell it.

Validate Your Idea with “Smart Money”

“Smart money” investors are those whom others respect as savvy investors; they are those who probably wouldn’t give you money without doing their homework, although I’m of the opinion that simply following the smart money without doing your own homework is a quick way to lose money. While getting “smart money” investors is certainly no guarantee of success, getting their input and blessing makes the rest of your job a bit easier.

I thought tapping into the OMS was a great solution, and at first look everyone else did, too, but I knew I needed the opinions of other people—people I trusted—besides my family and friends. I learned the value of this when we were trying to raise money for the health care software company. All of the investors we went to had the same concerns. And once you start hearing the same thing over and over again, you have to give it some credence. Learning why others failed and why it didn’t work was helpful in deciding what—or what not—to pursue.

Once Eric was on board, we called a few of our smart money industry contacts. We first approached Nathan Gantcher, at that time president of Oppenheimer & Co., who gave me my first job on Wall Street. We also went to Michael Price, the CEO of Heine Securities, the well-respected money management firm and one of our first customers at Merrin Financial. We then called Larry Zicklin, who was chairman of Neuberger Berman, one of the industry’s largest asset management firms.

I had previously sought out Nate, Larry, and Mike for their advice on an earlier idea for a discount institutional brokerage business. There were discount brokers for retail. If it were successful for retail, why not apply that to institutions, I thought. It turns out they were pretty different. I had put together a basic plan and I was excited to present it, but each one of these industry luminaries, separately, tore it apart. “It wouldn’t work,” they said, and they all gave me very solid reasons why.

They explained that it was the customer of the asset management firm that paid the broker’s commission, not the asset management firm itself. Since the cost did not come out of their pocket, they were not as cost sensitive, so they were less concerned about the commission rate. What was more important to the asset manager and what they were more interested in were the services and research they received from brokers. Was there something unique that would give them an edge, which they would gladly pay for with those commissions?

Their critique had sent me back to the drawing board. Now I had a new idea and I wanted their take. I knew they would be honest with me again. This time, we didn’t have much of a presentation, just a couple of PowerPoint slides. “We have this idea,” I said, when meeting with each individually. “I really need you to tear it apart; that would be most helpful.”

No one tore it apart; instead, they said they liked it. Bolstered by their enthusiasm, in each of the meetings I took it a step further. “Okay, I’d like you to be on the board of directors,” I said. “And how would you like to give me a million dollars to get it started?”

Nate and Mike agreed right then and there. Larry did not. Larry was a bit more cautious, and as head of Neuberger Berman he had many resources to help validate the idea. To that end, he set me up with the head trader at the investment management firm. Eric and I scheduled a meeting with Larry and the head trader, where I went through the whole proposition. It took probably about forty-five minutes. At the end of the presentation, the head trader said, “I don’t see anything wrong with it. I can’t poke any holes in it. But I hope to God it doesn’t work.”

Somehow that was good enough for Larry to commit $1 million. Like Nate and Mike, Larry knew that I had created a business before and had had a successful exit. It also didn’t hurt that the market was white hot. Valuations were high. We raised $3 million at a $30 million valuation in January 2000, two months after I had the idea, two part-time people, and a PowerPoint presentation.

Building Credibility Circles

If you want to potentially speed time to market, ensure beta customers, increase your valuation, and overall enhance your chances of success, you want to build circles of credibility. I had a certain amount of credibility at this point in my career, as I had already built a company and transformed an industry. This time, unlike when I started Merrin Financial, people knew me. Now, I also had something else on my side. Smart money—people who themselves had credibility and were well respected and were investing in our venture—that expanded our credibility circle. People more instantly thought, “If those guys liked the idea, there must be something to this.”

I wanted to build our credibility circle further. The third circle that I wanted to create was one consisting of the people who would use the service—traders. I called up a bunch of former Merrin Financial customers who were the head traders of large firms. It made sense to start with the biggest companies. They had most of the assets, and if they came on board, everyone else would as well. I called the head trader of Aim Management, which is now part of Invesco, and I also called folks at Putnam and Janus, among others. I knew that the more expansive your credibility circles, the more you stack the deck in your favor to successfully get financing, a better valuation, beta customers and launch.

Each person that I called had signed up for Optimark. I reached out very soon after Optimark failed, which meant they all had just recently spent a bunch of their own personal chips to get their companies to do all the paperwork, build an interface into Optimark, and get it set up on the desktops. They had expended a lot of resources, there was a lot of hype, and it had failed.

Everyone accepted a meeting with me; however, I’m not sure that anyone was happy about it. Who wants to sit through another attempt to solve this problem where all previous attempts failed and the last one spectacularly blew up?

We prepared for those presentations, and I knew there would not be much time to state our case. We prepared our 30-second pitch. We came in, they feigned happiness to see me, and then we sat down. I knew I had a very short window before they were going to kick me out. But in that short period of time, they started to perk up. They started asking questions, and then they became animated. They saw how this was different.

Once I saw that they got it, I asked them to poke holes in the idea—and they did. The original plan was to have everyone participate in this service—brokers, long-only asset managers, and hedge funds. But these traders were vehemently opposed to that. They wanted only asset managers to be able to access it. They wanted that exclusivity. They didn’t trust the sell side, and they didn’t want to interact with hedge funds. We agreed to this change.

They also voiced concerns about security. They would be sending their most sensitive information—orders before they were executed into the pool—so how would we safeguard it? We had to assure them their data was much more secure than the way they were trading currently. To prove that, we agreed to retain a third party, one of the big accounting firms, to audit us and make sure all the protections were in place and everything we were saying about their data’s security was in fact true.

There were other things they wanted that we couldn’t agree to. One of the features that we knew was absolutely critical to our success was our design for automatically “sweeping” all the orders into our pool. This meant that every order in their OMS would automatically flow into our pool without a trader’s intervention. This was how we would seamlessly fit into their workflow, our secret for building a critical mass of liquidity and how not to frustrate the traders. We knew the sweep was the critical component to achieve success. The traders would not have to select which orders came to Liquidnet. This was not something that anyone else had asked of them and not something that anyone would agree to without a deep understanding of how the system worked and the protections built in to safeguard their information.

Everyone rejected that feature. A large part of the trader’s responsibility was to pick and choose which order to send to which broker and they were extremely reluctant to give that up. It was a control issue, but also one that if we gave up on would destroy the whole model. Orders entered manually would be few, and the number of matches would be far fewer. Traders would stop using the system very quickly. This is what had doomed Optimark and all the other attempts before us. I didn’t want to spend time or money on a model I knew would fail. I held firm.

I made it very explicit. “Today, you give a broker an order. That broker then starts calling all of your competitors to tell them that they have this order, and you’ve just lost all control over where that information goes. Maybe it’s a really good broker, and they’re being really careful with the information—but maybe not. And the fact is that the probability of finding a cross is extremely small and those calls start the market moving against you.”

Then I explained how Liquidnet was different: “In this system, if there’s no match, nobody’s going to know anything. But if there is a match, there are only two people in the whole world who know that there’s something to be done and you’re one of them.” I also told them that the only way we would be successful and solve the liquidity problem was if they agreed to the sweep.

It was compelling enough to get a few of these guys to agree. At the end of those meetings I asked each to participate on my advisory board. Everyone accepted. This was the master plan. I now had a third circle of credibility. I knew this would help tremendously when we approached other firms and investors. We had the heads of trading at eight large asset managers committed to using the system and helping to make it succeed. More smart money and actual users had vetted the system. Now, investors would know we had something valuable in the works.

Overcoming the No-Go Issues

Things were looking promising with our credibility circles in place, cash in the bank, and large firms as our first potential customers. But we needed to get another stakeholder on board. For Liquidnet to work, we had to interface with the order management systems. I was well aware that the OMS business was a very competitive business. Everyone hated each other, and mostly they all hated me because Merrin Financial was by far the largest, and because I ended up cashing out while they remained duking it out among themselves.

But now I needed them. I had to go to these people—people who basically had pictures of me on their dartboards—and say, “Hey, I’d like you to interface with a new system that I’m building.” It wasn’t very likely they would be eager to help me. (It was more likely they would be eager to kill the idea.)

Additionally, all of these OMS players as a course of doing business always overcommitted and underdelivered to their paying customers. They didn’t have the bandwidth for more and now they were presented with a request do to more work for a new system that had no customers and no revenue.

However, amazingly, the OMS vendors agreed to meet with me. They were cordial, and they ultimately agreed to participate. Not that they didn’t try to exact a hefty cost! They asked for 50 percent of the revenue. The business model couldn’t support that, but we were able to negotiate that down significantly.

We came to an agreement on the economics, and the two major players “yesed” us along. We now had the missing mission-critical piece in place. We told the customers that everything was ready to go.

Then, when it was time to actually sign the agreement, the vendors suddenly refused. “Sorry, we’re not going to do it,” they said, offering little explanation. It was a bit too coincidental; it seemed as if the two major OMS vendors that had verbally agreed were in cahoots.

I was totally surprised—blindsided. We had spent six months with both of these vendors kowtowing and kissing rings. Now in the 11th hour they both did an about face and screwed us.

If we couldn’t get the OMS system integration, our solution wouldn’t work and we were dead on arrival. After a short period of depression and despair, we turned our thoughts to how we could overcome this. Remember that business is just a series of problems that have to be solved. The more creative you are in solving them, the better you are at business.

We needed to get creative. Thankfully, we knew firsthand from being in the OMS business that your priorities were set by your clients. We also knew from our work trying to get early customers at Liquidnet that there was tremendous pull that could be leveraged from our carefully built advisory board.

We identified and targeted the largest clients of each OMS vendor. If they weren’t already on the advisory board, we paid them a visit and invited them to join. They all agreed.

We explained that part of their role on the advisory board was to prioritize this integration with their OMS vendor. It worked. The advisory board members were invested in seeing Liquidnet succeed, and they knew its success rested on interfacing with the OMS. We won over enough large customers of the four biggest OMS vendors that they agreed to prioritize working with us to build the interface. It took longer than we wanted, but we got what we needed—with a little help from our friends.

The $100 Million Question

As soon as we got Larry, Nate, and Mike on the board we asked them to recommend venture capitalists, so we could go raise the money we needed to build the team, build the product, and launch the service. We knew approximately how much it would cost to build this service and the capital-raising market was hot. I also knew that an industry magazine was about to come out with me featured on the cover as one of the top 10 “Innovators of the Decade.” It even said, “The industry that he single-handedly created has taken on a life of its own, but knowing Merrin, he’ll just go out and create a whole new one.”¹ That seemed like a pretty good chip along with our credibility circles to go out and raise money with. We got enough copies so we could bring one to every meeting.

Our board members gave us the names of four venture capitalists, and we scheduled meetings with each. When you meet with venture capitalists, you typically have half an hour to pitch your business. You’ve got to get the idea across to them quickly. You need to bring your 30-second unique selling proposition. You have to have and share your unfair competitive advantage. If you have both of those, you also have to be prepared for when they ask you, “Okay, what valuation are you looking for here?”

Our prep work taught us that every decent presentation to a venture capitalist usually includes the same graph. In year 5 you hit $50 million of revenue—anything less than that growth curve would not typically be interesting to a venture capitalist. Knowing that they would discount whatever number we gave them and that they’d seen a thousand similar projections, Eric and I sat down and prepared beforehand to go about further differentiating ourselves. We knew the difference in valuation would come from the answer to several questions. How large was the problem and how necessary was the solution? Optimark demonstrated that for us. How large was the opportunity? Market sizing was easy to get—over $30 billion globally. What pieces did we have in place, and how well had we lined them up to succeed? Our domain expertise and our credibility circles answered that. “Okay, so what do you think the valuation should be?” I asked.

Eric tossed out, “If we can get $30 million out of our premoney valuation, that would be pretty amazing.”

It would. Remember, it was still Eric, me, and a PowerPoint. I said, “Well, I think we should ask for $100 million.”

The market for getting funded was hot, and since I liked my number better, we went with it. That was all the science and math we put into deciding on the valuation. It is important to understand that the timing in the market, the tail end of the dot-com bubble, was a greater factor and had more impact on our valuation than did our business plan.

We had to spend a lot of time prepping for just that question, so we wouldn’t crack a smile or lose it right there because if we did, it would be over. We would have lost. We practiced our answer over and over again.

It worked because we targeted a very large global problem with a unique solution; we had my reputation, our smart money board, and the head traders of eight large asset management firms on our advisory board. Three out of the four venture capitalists wanted to give us money. And they all promised us the same things: “Work with us and we’re going to help you and your team build this company and help sign up clients.”

I pretty much discounted all of that to zero. I told them honestly and point blank, “Thank you, but I’m going to go with the venture capitalist that gives us the highest valuation.”

Thomas H. Lee, Putnam Ventures, a joint venture between T. H. Lee, one of the most successful private equity firms, and Putnam, the large asset management firm, had just raised $1 billion for their first venture capital fund. They gave us a $75 million premoney valuation. They put in $10 million for an $85 million postmoney valuation. We were their first investment. The fund wasn’t even closed yet when they agreed to invest in us. The lesson in negotiating with venture capitalists and most other people is that if your starting ask is for less, you will agree on some discount to that number. Our valuation negotiation was a great result for two guys with a PowerPoint presentation. We put in place and did all the things laid out in this book, but it was also a sign of the times.

Make It Super Simple

With enough money to build the product and a sales team to sell it, we were off to the races. We rented some nasty office space (again!) on a dingy floor with a dingy bathroom in a dingy building, with a dog grooming service in the office right next to us. It didn’t stink, but it was noisy. Every time we were on the phone there was a dog barking in the background. “What is that?” we were always asked. “Where are you?”

I didn’t want the talent we were recruiting to see our grungy office space so we invited them to lunch at a nearby saloon. (The saloon was at one point shut down because of health violations. Seems I could never escape the mice.)

Most of our hiring prospects were ex–Merrin Financial employees. Just about every single person we recruited in Liquidnet’s start-up phase came on board. It was like a reunion. But more than that: we were able to accomplish things incredibly quickly because we all knew each other, we knew the business, and we knew better than anyone else in the world how to deliver the secret sauce. Who better to know how to integrate with the OMS than those who built the OMS?

We adhered to the important lesson I learned in Silicon Valley—a mandate to make it incredibly simple. This applied to both the idea and the product. We accomplished our goal to make the system so simple that the instruction manual would fit on the back of a business card. It was a single purpose application that would find liquidity without moving the market, without intervention by the trader. It had to fit seamlessly within their existing workflow and be usable “right out of the box.” We knew that desktop real estate was valuable and scarce and decided that instead of being a full-screen application like all the others at the time, we would take up only a very little portion of the screen. We designed little “chicklets” that alerted traders to a match and appeared only if there was an opportunity to trade a large block of stock right there and then.

I hired four salespeople: I put them in a room; I gave them a script; and we role-played for days on end. We practiced—everything from a cold call to getting the meeting to having the meeting and, of course, demoing the system. We left nothing to chance. They practiced while walking around the city, standing in front of their mirrors, taping themselves and with their significant others who—to some of their dismay—could do the pitch as well as they could. But by the time we were ready to start selling, the salespeople were ready.

We set a goal: To get to a critical mass of liquidity we needed 100 firms on the system when we launched. As we were developing the system, it became very clear that we were developing faster than we were signing up clients and getting the OMS vendors to integrate with our platform. As the system was getting closer to done, we lowered our expectations to 75 firms live by launch.

Eighteen months after I had the idea in the middle of the night, 14 months after we raised our first venture capital, we had significant money in the bank, a solid team, and a unique product and we were ready for launch. It was showtime. But by the time we flipped the switch and went live, we had only signed and installed 38 firms. It wasn’t the 100 firms I wanted, or the 75 I would have settled for, but we made the call that we had to be live and trading to get other firms to commit and come on board. We crossed our fingers and prayed to God for any trades at all.