Rewriting the VC Rulebook: Sequoia's Crucible Moment

Roelof Botha is a partner at Sequoia Capital, one of the oldest and most successful venture capital firms in the world. Not long ago, he announced that Sequoia Capital will carry out the most daring innovation since its establishment in 1972-breaking the ten-year cycle investment model of traditional VC, and building a permanently open structure around the name of "Sequoia Fund".

The conversation cuts from the details of Sequoia Capital's transformation, and the content extends to Roelof Botha's entire career: including his changes in the past 20 years, his days at PayPal, the common ground of legendary investor partners, and his comments on Square, YouTube And the investment review of companies such as Udemy.The content of the article comes from Patrick's dialogue podcast audio, compiled and compiled by TechFlow Friends member 0xtree.

*TechFlow Friends is a volunteer organization of Deep Tide TechFlow community.

TL; DR：(too long, didn’t read)

1. Today's venture capital operating model was invented in the 1970s and has not changed for 50 years.

2. The ten-year cycle of the traditional model will prematurely terminate the relationship between investors and investment objects.

3. It took a start-up company five years to achieve a value from 0 to 3. After five years, as a listed company, its accumulated total value will be even higher.

4. One situation may make me lose interest in investing: the founder is a mercenary rather than a missionary. Mercenaries wilt in the face of adversity.

5. Taking Square as an example, many companies have the possibility to create again, but most organizations are their own worst enemies, and many good ideas are often stifled within the organization.

6. The beauty of payments is that it helps grease the wheels of commerce. Although an overused term. But something of real value does make business easier.

7. I like the promise of smart contracts where you can embed cryptocurrencies with payment events to make transactions more seamless.

8. The promise of certain DeFi technologies in enabling smart contracts and reducing transaction costs is absolutely fascinating.

9. The real risk of the Metaverse is being controlled by large corporations.

10. What are the three most important things that I think will happen in the next six months for every company I work with? This will free you from the distractions of the little things in front of you.

11. When recruited to Sequoia Capital, I had a feeling that if I was successful, I would be able to play an important role in future partnerships. I don't just join in to work for other people, to be their servant or lackey.

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Rewriting the VC rulebook

Patrick: Talk about how you think about this change? What problems does the new structure try to solve?

Roelof: Today's venture capital operating model was invented in the 1970s and was mainly driven by the historical background at that time. It has not changed for 50 years, which is a bit backwards for disruptors who reshape the industry through investment.

The traditional model problem is with closed-end 10-year funds. Traditional venture capital institutions must strictly abide by a 10-year fund duration, that is, fund managers must sell their holdings when the 10-12 year (the longest period) expires.

When we look at established businesses, the longevity of the cycle doesn't match Sequoia's original intention of finding exceptional founders who can build legendary companies and stand the test of time.

For example, in seed investment, we help the founders find a market for their business model when they have only a rough idea, and recruit a suitable executive team, and then help them overcome the difficulties on the road to success. We have all the background, the relationship with the founders, and the ability to help them continue to thrive.

But the default of the traditional model's 10-year cycle -- that is, exit the board and distribute stock shortly after the IPO. This prematurely ends the relationship between investor and investee, forcing a misalignment of goals between startup and investment partner.

Why IPOs should be a destination for investors I have now worked for a decade or more in the growth of several companies. Why does an IPO mean venture capitalists have to step off the board?

And we realize that for these great businesses, they continue to compound and most of the value accrues post-IPO. So, if you think about it from an LP perspective, at Sequoia, we work for what we call great causes. The vast majority of our LPs are endowments, foundations and nonprofits. Our job is to generate returns for them. So why are we selling shares so quickly after so much of the return happens after the company goes public? so,Sequoia Fund is really designed to meet two goals: to help founders have a more durable capital base, while helping LPs to obtain better returns.

Patrick: Maybe you can review the process of investing in Square and use it as an example to illustrate the importance of the new structure. After all, from the perspective of real numbers, Square is undoubtedly a very successful case.

Roelof：We talked to the company in 2010 and made an investment commitment, the real investment closed in January 2011 at 95 cents a share and I was still on the company's board. By the time Square went public, the IPO price was $9, roughly a 9x return. But we choose to distribute patiently within three to four years of the IPO, so the final average sale price per share is between $80 and $90, and the rate of return is about 90 times. This patience has had a huge impact on LP earnings.

Looking at the review, Square's total market value at the time of IPO was 2.95 billion. Five years after the IPO, the total value was 86 billion, and today it is worth 11.5 to 12 billion.

in some sense,It took a start-up company five years to achieve value from 0 to 3, and as a public company five years later, the total value it accumulated was even higher.

Patrick: Maybe you can talk specifically about how the new structure will work? Suppose I am the big LP of Sequoia. I made some investments in every new group of funds or every fund that Sequoia launched. What will happen in the future?

Roelof：The background can be a bit complicated. In the initial stage, the fund we operated was obviously not launched within Sequoia Fund.

In short, the adjusted Sequoia Fund is an open fund with a liquid investment portfolio, and it is also the first full-chain cross-fund that spans from seed-stage start-ups to companies listed on the public market. The way this fund works is to raise funds from limited partners LP, and then allocate these funds accordingly to a series of small closed sub-funds by stage, these sub-funds are in the whole life cycle of the investment target company (seed to post-listing) , can carry out venture capital investment, there is no exit period, and the income of the fund will flow back to the Sequoia Fund, and Sequoia can hold shares for a long time.

In the new structure, Sequoia's limited partner LP retains the right to repurchase and distribute funds to sub-funds every year. After the companies in the portfolio are listed, Sequoia will no longer distribute its shares to LPs, but will allow Investors transferred their shares to this newly established non-duration Sequoia fund, which will continue to be managed by Sequoia.

This approach fundamentally simplifies the complexities of capital mobilization for LPs, allowing them to better manage cash flow.

Then we provide LPs with the ability to redeem within the fund. Part of the problem with past distribution models was that it made an all-or-nothing decision for everyone. Once the distribution decision is made, everyone gets their stake. Sadly, LPs usually sell securities as we distribute them.

This also makes sense. If you were managing a $5 billion or $8 billion endowment, and you got a stake in some new company that you didn't know, and you didn't have a stock trading desk, what else would you do? Therefore, these securities will be attracted to the Sequoia Fund, but if you, as an LP, face liquidity crunch and need to fund some new educational activities or medical research, you can redeem part of the balance in the Sequoia Fund so that we can Demand-adjusted liquidity.

Patrick: In summary, the main fund is a bit like a customizable tool for LPs, allowing LPs to decide where their dollars go, but it also creates more liquidity and optionality at the back end, reducing the trouble of managing and redeeming funds . Thereby improving capital utilization.

Roelof：Very correct, but the most important thing is our judgment on holding these good projects for a long time and the ability to bring high returns to LP. Square is an example. Therefore, we need all legal disclaimers because past performance is no guarantee of the future.

Patrick: After the IPO, stocks are closely related to the market every day. It is volatile and completely different from the traditional venture capital world. What are your thoughts on this change?

Roelof：In a sense, we've been very patient with distribution over the years. We currently hold $45 billion worth of public securities in our US and European operations, and I receive weekly reports on the dynamics of the portfolio that the team will be working on. So, we are used to living with this daily fluctuation.

The key is that we need to think differently, that is, we need to think about the overall decision rather than the distribution decision, because selling or distributing is a very dangerous breach of contract. When you're lucky enough to work with really good teams, you should have different defaults.

Because the only way to get multiple returns is to partner with incredibly ambitious founders and patiently let them continue to scale the business.

Patrick: What are the fringe benefits of this new structure?

Roelof：The traditional investing world has been operating under a set of regulations known as the VC Exemption, which mandates that no more than 20% of a fund be invested in non-primary offerings. That is to say, betting including the secondary market, encrypted market, public securities, and fund-to-fund investment is limited to 20% of the total size of the fund.

However, it takes many years for many companies to go public, which will limit the fund's capital flexibility to a certain extent. When eBay acquired PayPal in 2001, when we accepted continuous bids from eBay, we also took a little bit of money off the table as a team to make funding more resilient.

Over the years we have supported some emerging managers, for example through the Scouts program (VC Cavalry Program), we were the first to launch the Scouts program, but all similar ideas are subject to the 20% VC exemption limit. This makes us have to re-examine ourselves. Another point is the investment in the encryption field. We have been active in the encryption field for five years and have achieved very good returns. But the same problem is that in the current fund structure, what can I do? things will be limited. New structures might reasonably ease the constraints.

Patrick: What is the fee structure for LPs in this new structure? How will it work?

Roelof：Fees are constant in our organization's Future Seeds Venture Growth Fund. But now there is an additional pool of capital flows for which we have a fee structure that the LPs agree to, which has very low management fees.secondary title

how the world is changing

Patrick: From a founder's perspective, how do you see the evolving capital landscape?

Roelof：Global interest rates are so low. We are seeing a massive recession in monetary and fiscal policy due to the COVID pandemic, affecting all types of assets, including venture capital.

In this environment, people have truly realized the scale effect brought about by technology injection.

Twenty years ago, when I was working at PayPal, 200 million people on the planet had access to the Internet. The vast majority of them are dial-up. But you look at the capabilities we have today, technology touches everyone and every industry, and if you create an effective company, it can reach a global audience and gain traction very quickly, which allows you to grow your business faster than ever before . High growth will naturally attract more capital.

The choice facing entrepreneurs is when do you need help, when do you need a business partner, and when do you need transaction capital? Who gets on the board and who helps build the business? Are they suitable?

We recently caught up with Jack Dorsey at a founders event, and he talked about how he gave back 1% of Square's company twice. It is not his own 1% of the equity, but the company's 1%, because he wants to supplement the talent pool, so that he can hire more excellent talents to help the company succeed. His insights are:"I want a small portion of something that's really successful and really has a big impact, not hoarding as much equity as possible for myself."I think what he did was very successful.

Patrick: How do you think the landscape is different today than in the past? Or what are the winds of change today?

Roelof：One of the biggest changes I've noticed over the past 15 years is that the founders are ambitious enough that when you see him accomplish something, it's kind of like a proof of existence from science. He can provide a template for reference. Just like PayPal, he was once acquired by 1.5 billion US dollars, and today it is a company worth more than 300 billion US dollars.Founders are more patient than ever, with more global ambition and a sense of purpose. Not only in the United States, but also in Europe.

Patrick: What are the consequences of this change?

Roelof: By not taking shortcuts, not using duct tape, trying to build things right, I see founders thinking more carefully about the composition of their management teams.

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Roelof's Investment Framework

Patrick: When you first meet with a founder or founding team, what is your goal? Like what are you trying to figure out?

Roelof：A difficult and interesting question.Every meeting is a sale, just like a good interview. It's a delicate balance between finding good questions and asking them in an engaging way, and building trust in the conversation.

Frankly, finding problems is valuable in itself. We want founders to come back and say to us, "You asked the toughest questions, and that's why I want to work with you, because you sharpen my mind. You help me think differently about mine." Business. That’s the kind of thinking I want for the future.”

I love trying to understand their eureka moments. It is said that when Archimedes took a bath, he was so blessed that he figured out how to measure the volume of the crown, so he exclaimed in surprise: "Eureka!".

Every time I would like to figure out how did the founder’s inspiration and sense of mission come about? For example, Natera, a listed company specializing in bioinformatics, has the world's leading non-invasive prenatal testing technology. The founder, whom I met in high school, has a Ph.D. in electrical engineering from Stanford and now studies biology and genetics as best he can because he believes people need better care.

Because he found that there is no better technology in the 21st century to help families have healthy children. That's motivation, it's mission driven, and they'll probably spend the rest of their lives working on that.

Patrick: To what extent do you want to understand the underlying business model or revenue model of a business at an early stage?

Roelof：There is almost no such thing. I always think about value creation before value capture. It is very rare for a company to create or provide great value without building a good business. Now to build a great business instead of a good one, you need some ingenuity in your business model.

Patrick: What circumstances made you lose interest in the company early on?

Roelof：You can say no to every company, that's part of the challenge. Don Valentine once said to us that our business is investing, not not investing.

Personally, one situation can turn me off:secondary title

Square, YouTube, Unity, and MongoDB

Patrick: As a major investor and board member of Square, YouTube, Unity and MongoDB. Do you have any experience to share?

Roelof：I know the payment track very well, and that's part of the reason for my enthusiasm for related investments. One of the real surprises is that Square was able to build a large consumer business, given that the company's original DNA was serving small businesses.

This proves that this company has an extraordinary capacity for secondary creation, which is actually the ability to give life to new ideas.Because most organizations are their own worst enemy, many good ideas are often stifled within the organization.

Patrick: Thinking back to the early days of PayPal, what is the most exciting thing about the future of payments? What's interesting about today's payments landscape?

Roelof：The beauty of payments is that it helps grease the wheels of commerce. Although an overused term. But something of real value does make business easier.

This is what we concluded after eBay acquired PayPal. There is a tight integration between PayPal and eBay's payment products, which accelerates commercial activities on eBay. This is the benefit that general payments can bring to the economy and GDP growth - making commerce easier.

I like the promise of smart contracts where you can embed cryptocurrencies with payment events to make transactions more seamless. The promise of certain DeFi technologies in enabling smart contracts and reducing transaction costs is absolutely fascinating.

Patrick: The theme of this week's business and market-Metaverse, I feel that Unity is a good opportunity. How do you see its role in the overall trend?

Roelof：Unity is definitely part of the metaverse communication, because it does real-time 3D interactive technology. 70% of the top 1000 games on the App Store are currently built on Unity. Unity is the engine that powers the development of the metaverse, and besides, they have use cases in manufacturing and automotive.

What sets Unity apart from others is that it fundamentally believes in an open ecosystem.Because in my opinion the real risk of the metaverse is being controlled by big corporations.

Patrick: Why can open decentralization bring good effects?

Roelof：The downside of openness is interoperability. If things are very open, the plumbing between technologies can be fragile and things won't work seamlessly. But it's a solvable technical challenge.

Unity can help solve this challenge so when developers work on Unity, the game or application they develop can run on all hardware devices. If you build an application in Unity, it will run on iOS, Android, macOS, Windows, PlayStation and even Xbox, it can be used for all different platforms.

As long as it's possible with a company like Unity, you can tap into everyone's creativity.If it is a closed ecosystem, it will become a monopoly, and the monopoly does not need to innovate.Of course, the trade-off is whether the technology brings a good experience? Otherwise consumers would choose a closed system.

Patrick: What is the biggest feeling of investing in YouTube?

Roelof：It's great to get involved early! There were three founders who were my friends and colleagues from the PayPal days when they were in Chad's garage in Menlo Park, and they got into Sequoia's office at the beginning. Sequoia was their first location, and I worked with them every day for the first few months, which was an incredible experience, and together we took the company to critical mass.

Early on Chad, Steve, and Jawed joined me to discuss how YouTube can be a platform for creators. We also thought about how we could connect creators with brands to support them in commerce, and ultimately, to make a living on YouTube. Now it's real! It was unimaginable 25 years ago that so many people voiced their voices on it, how amazing it is.

Patrick: Regarding MongoDB, it mainly faces developers. I am more interested in your views on the developer world.

Roelof：Over a decade ago, we had a theme for Strategic Insights internally called The Rise of the Developer. This informs our investment in Unity, which also has developers, GitHub, MongoDB, Confluent, and many other businesses.

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Board members, legendary investors and melting pot moments

Patrick: How do you ensure that you can help the founders complete the transition at critical points?

Roelof：Sometimes a company may have one or a few founders with product technical experience, but they have never built a sales team before and need to go to market. You can help the business with a board member who is good at that area, who may not be as focused as I am on the key milestones, but who is very good at building the sales force and understanding the go-to-market moves, which is more functionally focused.

I read a book many years ago called "The Hinge Factor". The subtitle of the book isHow chance and stupidity changed the course of history. So I'm always looking for key moments when a company might make a left or right turn on the road. It has a huge impact on the outcome.

Patrick: Tell me more about how you improved your ability to capture key nodes? (maintain accuracy)

Roelof：To be honest, one is experience, and the other is that after entering Sequoia, we have received relevant training. The third is regular deep thinking,What are the three most important things that I think about every company I work with that will happen in the next six months? This will free you from the distractions of the little things in front of you.

Patrick：You just mentioned that board members represent different skills on the board and have different utility to the company, and I believe the same answer applies to what makes a great investor. You've worked with Mike Moritz, Doug Lyon, Don Valentine, Jim Getz, and many other legendary investors. What do they have in common? What is the DNA of this great investor?

Roelof: Curiosity is the most important thing.

Of course, he may need analytical skills, judgment on people, intuition on market trends, etc. You can read the memo on YouTube, which is now public. It takes imagination to support three people with a product that has 9,000 signups. So you also need imagination. But the most important thing is curiosity. Are you interested in learning something new? Are you interested in meeting new people? Are you interested in hearing their thoughts on a company and how they might change the world? If you lose this curiosity, you become bored. Then, you should probably stop working as an investor.

Patrick: What makes a great investment memo?

Roelof：Clarity and conviction.

The ability to explain things clearly. I worked with a guy named Shankar Balasubramanian, who was a professor of chemistry at the University of Cambridge. He invented the chemistry behind next-generation sequencing, and he founded a company called Solexa, which was acquired by Illumina and formed the backbone of next-generation sequencing products. He is absolutely gifted and talented. He has the ability to explain extremely complex topics in a way that I can understand. That's the gift for me, when you can clearly boil down complex business and technology, anyone can read it and understand it. And to me, that means you've mastered it.

A lot of people have good analytical skills and they can tell you. On the other hand, we're in the business of making decisions, and there's always uncertainty, so having to make calls when it's not clear, so you need that belief, that willingness to stick your neck out and offer advice.

Patrick: Around 2017, you took over additional responsibilities to oversee the Sequoia franchise in the US. I know you have been a driving force in the big changes in the way they do business in the US. How do you see the skills required to do that job differently than a traditional general partner, pure investor job?

Roelof：I started thinking more about the assembly of the team. Do we have the right genes? Do we have the right candidate? Are they working harmoniously? How are we working together? We have an early team and a growth team, how do we make sure there is a great chemistry between them? As a business, we have decided to add significant operational capability to our organization.

The venture capital business was a bit of a family business 25 years ago, basically a handful of people making investment decisions, that's all. Today, our organizations are far more complex. We have a marketing team, a community team, and a talent organization that helps founders recruit. We also have a technical team within Sequoia that helps us build the technology that we can leverage.

Business is becoming more and more complex. So the job of the leader is to ensure collaboration across teams, similar to the job of leaders in other organizations, where more time is spent thinking about people than product.

Patrick: I like the point you made earlier that the main change is that the founders have changed the scope of their aspirations. I'm curious if the same applies to you and companies. Sequoia has a legendary history, what do you think of the significance of this brand?

Roelof：First, let me talk about branding. In the 1970s, when nearly every other professional services firm, law firm, accounting firm, etc. put the founder's name on the door, Don made a very deliberate decision to choose a redwood tree with thousands of years of life Do brand names because he wants to create a partnership that will outlive him. When you do this, the people you recruit don't work for you, they work with you and inherit the business.

When I was recruited to Sequoia, I had a feeling that if I was successful, I would be able to play an important role in future partnerships. I don't just join in to work for other people, to be their servant or lackey.We structured Sequoia as an essentially permanent partnership to the extent permitted by law, we view Sequoia as a platform that provides us with the ability to serve founders and LPs. Our job is to put partnerships in better shape.

And my job is to help Sequoia recruit the next generation of teams who will succeed the existing leadership partnerships. In turn, their role will be to keep the Sequoia platform going strong.

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how to think about the world

Patrick: Going back to the point about curiosity. What set of trends are you most curious about in the world today?

Roelof：Genetic Engineering. I'm fascinated by this, and with all the genetic engineering capabilities we're inventing, the development of precision genetic engineering is critical to the future of the world.

Patrick: What do you think technology needs most in the world today?

Roelof: Sustainability. But depending on how you phrase the question, I think technology wants to show that it can improve the lives of most people, not some. And it can really make our Odaily a better place.

Patrick: What was the biggest hurdle?

Roelof：Accurate measurements may be one of them. Partly because people don't have the right information to refer to, and partly because we don't have internalized externalities. Like ESG (Environmental, Social and Governance), if we ignore these externalities and simply pursue profit, it will come at the expense of our livelihood as a species.

Although I am a capitalist and an economist, the market system is not perfect in many ways, and we need to perfect it with sound institutions to make it flourish.

Patrick: You started your career as an actuary. How does this career affect your future investment experience?

Roelof：My undergrad professors used to quip that accountants are trained to think a year in arrears, while actuaries try to think 20 years in the future. I didn't fully appreciate the value of this statement until I joined Sequoia.Because most of the poor decisions are made because of short horizons and ignore the importance of compound interest, although in prehistoric humans, compound interest did not really help humans. But it's invaluable when you think about how a business grows. Going back to the establishment of Sequoia Fund, people actually underestimated the continuous compounding ability of truly successful companies.

Patrick: What's the difference between talent and genius?

Roelof: For me, genius is more about inspiration, talent is more about sweat. You can have a talented executive in a specific category who can help you go from N to N+1. But you need a genius to go from 0 to 1.

Patrick: I think you need both. This is probably the finishing touch.

Roelof：I don't like to put too much emphasis on specific attributes of either side. Like playing rugby, part of the appeal of rugby is that it is a complete team sport. And there is no measurement of individual indicators. Nobody walks out on the football field and says, "Oh, I gave five passes, or I ran for a hundred yards." It's just, did we win as a team? You don't even count if you passed the ball to the scoring teammate. The important thing is we get the try and we win as a team.

I also need this complementarity when I think about building a business,You need to respect and appreciate the different talents that people bring, not just praise the quarterback.