Conversation with Sequoia Partners: The DNA of great investors is curiosity

0xtree, Deep Tide TechFlow 

Roelof Botha is a partner at Sequoia Capital, one of the world's oldest and most successful venture capital firms. Last week, he announced sequoia's boldest innovation since it was founded in 1972 -- breaking away from the traditional VC 10-year investment model and creating a permanent open structure around the name "Sequoia Fund".

The conversation starts with the details of sequoia's transformation and extends to Roelof Botha's entire career: That includes his changes over the past 20 years, his days at PayPal, the similarities between his legendary investor buddies, and his reinvestments in companies like Square, YouTube, and Udemy. This article is from Patrick's podcast of conversations.

Abstract:

1. Today's venture capital business model was invented in the 1970s and hasn't changed in 50 years.

2. The traditional ten-year cycle prematurely ends the relationship between investor and target.

3. It takes five years for a startup to go from zero to three in value, and five years later, as a public company, its cumulative total value is even higher.

4. One thing that might put me off investing is that the founders are mercenaries rather than missionaries. Mercenaries will wither in the face of adversity.

5. Take Square for example. Many companies have the potential to reinvent themselves, but most organizations are their own worst enemies, and many good ideas are often stifled within them.

The beauty of payment is that it helps grease the wheels of commerce. Although it's 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 activities to make transactions more seamless.

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

The real risk of the meta-universe is being controlled by big corporations.

10. I think about the three most important things that will happen in the next six months for each company I work with. This will get you out of the little things at hand.

11. When recruited to Sequoia Capital, I had a feeling that if I was successful, I would be able to play a significant role in future partnerships. I didn't just join in to work for others and become their servant or lackey.

Genius is more 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 zero to one.

Rewrite the VC rule book

Patrick: How do you think about this change? What problems does the new structure attempt to solve?

Roelof: Today's venture capital business model was invented in the 1970s, driven largely by the historical context of the time, and hasn't changed for 50 years, a bit of a throwback to the disrupters who used investment to reshape the industry.

The problem with traditional models is closed-end 10-year funds. Traditional venture-capital firms are strictly subject to 10-year fund maturities, in which managers have to sell their holdings at the end of 10 to 12 years (the maximum).

When we look at existing businesses, the life of the cycle doesn't match Sequoia's desire to find special founders who can build legendary companies that will stand the test of time.

For example, in seed funding, we help founders find a market for their business model when they have only a rough idea, recruit the right executive team, and then help them get over the bumps in the road to success. We have all the background, the relationships with the founders, and the ability to help them continue to thrive.

But the default setting for the traditional ten-year cycle is to step down from the board and allocate shares soon after the IPO. This prematurely ends the relationship between the investor and the target, forcing a mismatch in goals between the startup and its partner.

Why should ipos be a destination for investors? I've now worked on the growth of several companies for a decade or more. Why does an IPO mean that venture capitalists must step down from the board?

And we realize that for these great companies, they continue to compound and most of the value accumulates after the IPO. So, if you think about it from an LP point of view, at Sequoia, we work for what we call great causes. The vast majority of our LP's are endowments, foundations, and non-profit organizations. Our job is to create a return for them. So why do we sell stock so quickly when so much of the return happens after the company goes public? So sequoia is really designed to meet two goals: to help founders have a more durable capital base, and to help LP achieve better returns.

Patrick: Maybe you could replay the Square investment process and use it as an example to illustrate the importance of the new structure, since Square has been a huge success story in terms of real numbers.

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'm still on the board. By the time Square went public, its IPO price was $9, a roughly nine-fold return. But we chose to patiently distribute over the three to four years of the IPO, so we ended up selling at an average price of $80 to $90 per share, with a return of about 90x. This patience has had a huge impact on LP earnings.

Square's total IPO value was $2.95 billion. Five years after the IPO it's worth $86 billion, today it's worth $11.5 to $12 billion.

In a sense, it takes five years for a startup to go from zero to three in value, and five years later, as a public company, its cumulative total value is higher.

Patrick: Perhaps you could talk more specifically about how the new structure will work? Let's say I'm the big LP of sequoia. I made some investments in every new fund group or fund that Sequoia launched. What will happen in the future?

RoelofThe background can be a bit complicated. The fund that we ran in the initial stage was obviously not started inside sequoia.

In short, the restructured Sequoia fund is an open fund with a liquid portfolio, and the first cross-fund with a full chain spanning from seed-stage start-ups to public market companies. The operation of the fund raising funds from the limited partners LP, then the funds allocated to a series of corresponding by phase of small closed funds, these funds invest in the company's full life cycle (seed to listed after), can be in risk investment, do not set out of deadline, the accrual of fund flow back to the sequoia fund, Sequoia can hold shares for a long time.

The new structure, sequoia limited partners LP every year to keep the buyback rights and the rights of the funds allocated to the son in a portfolio after company listed, the sequoia will no longer to distribute their shares to LP, but allow investors to transfer shares in the new term without time limit in the sequoia fund, and continue to run by sequoia.

This approach fundamentally simplifies the capital call complexity of LP, thus better managing cash flow for them.

We then provided redemption capabilities for LP within the fund. Part of the problem with the old distribution model was that it made an all-or-nothing decision for everyone. Once the allocation decision is made, everyone gets their share. Sadly, LP usually sells securities as soon as we distribute them.

And that makes sense. If you run an endowment of $5 billion or $8 billion, and you get stakes in some new company you don't know, and you don't have a trading desk, what else do you do? So, these securities will be attracted to the Sequoia fund, but if you are facing a liquidity crunch as an LP and need to fund some new educational activities or medical research, you can redeem some of the balance in the Sequoia Fund so that we can adjust the liquidity to everyone's needs.

Patrick: In summary, master funds are a bit of a customizable tool for LP, allowing LP to decide where their dollars go, but also creating more liquidity and optionality on the back end, reducing the hassle of managing and redeemable funds. Thus improve the utilization rate of funds.

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

Patrick: What do you think about the change after the IPO, when stocks are tied to the market every day, and it's volatile, which is completely different from the traditional venture capital world?

Roelof: In a sense, we've been very patient with distribution for years. We currently hold $45 billion worth of public securities in our U.S. and European operations, and I receive weekly updates on the dynamics of the portfolio that the team handles. So, we are used to putting up with these daily fluctuations.

The point is that we need to think differently, that we need to think about overall decisions rather than distribution decisions, because selling or distributing is a very dangerous default. When you're lucky enough to work with a great team, you should have different defaults.

Because the only way to get multiples is to work with founders who are incredibly ambitious and patiently let them continue to scale their business.

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

Roelof: The traditional investment world has been operating under a set of regulations known as the VC exemption, which requires that no more than 20% of a fund be invested in non-primary issues. That means bets on secondary markets, crypto markets, public securities and funds-to-fund investments are limited to 20% of the fund's total size.

And many companies take many years to go public, which limits the funds' flexibility on a procedural basis. When eBay bought PayPal in 2001, we accepted a succession of offers from eBay, and as a team we also took a little money off the table to make the money more flexible.

We have supported some emerging managers over the years, such as through the Scouts programme (the VC Cavalry programme), where we were the first to launch the Scouts programme, but all such ideas have been limited by the 20% VC exemption limit. That made us have to look at ourselves again. Another thing is investing in crypto. We've been active in crypto for five years now and we've had very good returns, but the same thing is that I'm limited in what I can do with the current fund structure. The new structure may reasonably ease restrictions.

Patrick: What is LP's fee structure in this new structure? How will it work?

Roelof: Fees are constant in our organization's Future Seed Venture Growth Fund. But now there is an additional pool of capital flows for which we have adopted a fee structure agreed by LP, which has a very low management fee. I personally invested more than a third of my net worth in new products. I think what works for LP works for us. By investing a lot of our own capital with our clients, we created a fee structure with fantastic incentives that rewarded us only when our investments exceeded a benchmark.

How has the world changed

Patrick: How do you see the evolving capital landscape from a founder's perspective?

Roelof: Global interest rates are so low. We are seeing a massive decline in monetary and fiscal policy due to the COVID-19 pandemic, which is affecting all types of assets, including venture capital.

In this environment, people are really aware of the scale effects of technology injection.

Twenty years ago, when I worked at PayPal, 200 million people on the planet had access to the Internet. Most of them have dial-up Internet access. But you look at the ability that we have today, technology touches everyone and every industry, and if you create an effective company, it can attract a global audience and get noticed very quickly, which allows you to grow your business faster than ever before. High growth naturally attracts more capital.

The choice for entrepreneurs is when do you need help, when do you need a business partner, and when do you need trading capital? Who sits on the board, who helps build the business? Do they fit?

We recently met With Jack Dorsey at a founders' event, where he talked about returning 1% of Square's equity to the company twice. Not 1% of his own equity, 1% of the company, because he wants to replenish the talent pool so he can hire more good people to help the company succeed. His insight: "I want a small piece of something that really succeeds and really makes a big difference, rather than hoarding as much equity as possible for myself."   I think he 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 in the last 15 years is that the founder is ambitious enough that when you see him accomplish something, it's kind of like proof of existence from science. He can provide a template for reference. Like PayPal, it was bought for $1.5 billion, and today it's a company worth over $300 billion. Founders are more patient and have more global ambition and mission than ever before. Not just in America, but in Europe too.

Patrick: What will be the result of this change?

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

Take Square, for example. Square Cash didn't exist for the first four or five years of its existence. Today, it's a huge business with 10 million users. Jack once said: the company has multiple nodes of secondary innovation, how do you encourage the team, so that creativity can flourish in the organization and produce more flowers of results.

Roelof's investment framework

Patrick: What was your goal when you first met with the founders or founding team? Like what are you trying to figure out?

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

Frankly, identifying problems is valuable in itself. We want founders to look back and say, "You ask the toughest questions, that's why I want to work with you, because you sharpen my mind. You help me think differently about my business. That's the kind of thinking I want for the future."

I like to understand their Eureka moments. Archimedes is said to have been blessed in his bath, figuring out how to measure the volume of his crown, and exclaiming in surprise, "Eureka!" .

How does the founder's inspiration, his sense of mission happen? Natera, a publicly traded company specializing in bioinformatics, is one of the world's leaders in non-invasive prenatal testing. I met the founder in high school, and he had a PhD in electrical engineering from Stanford, but now he's doing everything he can to study biology and genetics, because he thinks people need better care.

Because he found that in the 21st century people don't have better technology to help families have healthy children. That's the motivation, it's mission-driven, and they'll probably spend the rest of their lives working on it.

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

Roelof: There is almost no such thing. I always think about value creation before I capture value. It is very rare for a company to create or provide great value and fail to build a good business. Now to build a great business rather than a good one, you need to be a bit original in your business model.

Patrick: What would make 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 told us that our business is investing, not not investing.

Personally, I might lose interest in the fact that the founders were mercenaries rather than missionaries. Because mercenaries will wither in the face of adversity.

Square, YouTube, Unity and MongoDB

Patrick: Major investor and board member of Square, YouTube, Unity, and MongoDB. What experience do you have to share?

Roelof: I know a lot about the payment track, and that's part of the reason I'm passionate about investing in it. One of the real surprises was that Square was able to build a large consumer business, since the company's original DNA was serving small businesses.

It's a testament to the company's remarkable ability to reinvent itself, which is essentially the ability to bring new ideas to life. Because most organizations are their own worst enemies, many good ideas are often stifled within them.

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

RoelofThe beauty of payments is that they help grease the wheels of commerce. Although it's an overused term. But something of real value does make business easier.

This is what we concluded after eBay acquired PayPal. There is a close integration between PayPal and eBay's payment products, which accelerates business activities on eBay. That's what general payments can do for the economy and GDP growth -- make it easier to do business.

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

Patrick: This week's business and marketing theme -- the metasexes -- feels like Unity is a great opportunity, how do you see it playing a role in the overall trend?

RoelofUnity is definitely part of the metasurverse communication because it does real-time 3D interaction. Seventy percent of the top 1,000 games on the App Store are currently built in Unity. Unity is the engine that powers the development of the metasverse, and they are useful examples in manufacturing and automotive.

What sets Unity apart from the others is that it fundamentally believes in open ecosystems. Because it seems to me that the real risk of the meta-universe is being controlled by a corporation.

Patrick: Why is open decentralization good?

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

Unity can help solve this challenge so that when developers work on Unity, they create games or applications that run on all hardware devices. If you build an application in Unity, it will run on iOS, Android, macOS, Windows, PlayStation, and even Xbox, and it can work on all different platforms.

As long as a company like Unity is possible, you can tap into everyone's creativity. If you have a closed ecosystem, you have a monopoly, and the monopolist doesn't have to innovate. Of course the tradeoff is does technology make for a good experience? Otherwise consumers will opt for closed systems.

PatrickWhat was the biggest feeling about investing in YouTube?

Roelof: It's great to get involved early! Three of the founders, friends of mine and colleagues from the PayPal days, started out in sequoia's office in the Chad garage in Menlo Park. Sequoia was their first office, and I worked with them every day for those first few months. It was an incredible experience, as we brought the company to critical mass.

Chad, Steve, and Jawed joined me earlier to talk about how YouTube is becoming a platform for creators. We also think about how we can connect creators with brands to support their business and ultimately make a living on YouTube. Now it's real! There are so many voices on it, it would have been unimaginable 25 years ago, it's amazing.

Patrick: With regard to MongoDB, which is primarily for developers, I'm more interested in your view of the developer world.

Roelof: More than a decade ago, we had a topic of strategic insight internally called the rise of the Developer. This informed our investment in Unity, which also has developers, GitHub, MongoDB, Confluent, and many others.

Right now, there are about 25 million people on the planet who write software for a living, but the great products we use today depend on a very small number of people, so we need to empower those developers to make the technology or product that can increase productivity have a multiplier effect on the world.

Board members, legendary investors and Melting pot moments

Patrick: How do I make sure I can help the founder with the transition at key points?

Roelof: Sometimes a company may have one or several founders with product technology experience who have never built a sales force before and need to go to market. You can get board members who are good at that area to help the business, and they may not be as focused on the key nodes as I am, but they are very good at building a sales force and understanding the go-to-market action, which is functionally more targeted.

I read a book years ago called The Hinge Factor. The subtitle of the book is how Chance and Folly changed the course of history. So I keep looking for key moments when the company might turn left or right on the road. It has a huge impact on the outcome.

Patrick: Tell me more about how you improved your ability to capture key points. (Keep it accurate)

Roelof: To be honest, one is experience, and the other is after entering Sequoia, we have received relevant training. Third, frequent deep thinking. I think about the three most important things that will happen in the next six months for each company THAT I work with. This will get you out of the little things at hand.

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

RoelofCuriosity is the most important thing.

Of course, he may need analytical skills, judgment of people, intuition about where the market is going and so on. You go to YouTube's memo, it's public now. It takes imagination to support three people with a product that has 9,000 registered. 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 what they think about a company and how they will change the world? If you lose that 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 Cambridge University. He invented the chemistry behind next-generation sequencing, and he founded a company called Solexa, which was acquired by Illumina and forms the backbone of next-generation sequencing products. He was absolutely gifted and brilliant. He has the ability to explain extremely complex topics in a way that I can understand. That to me is the gift that 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 you have to make calls when it's not clear, so you need that belief, that willingness to stick your neck out and make suggestions.

Patrick: Around 2017, you took over additional responsibilities to oversee sequoia's U.S. franchise. I know you've been the driving force behind major changes in the way they do business in the United States. How do you see the skills needed to do this job as different from the traditional general partner, pure investor job?

Roelof: I started thinking more about team assembly. Do we have the right genes? Do we have anyone in mind? Do they work harmoniously? Do we work well together? We have an early team and a growth team, how do we make sure there's great chemistry between them? As a business, we have decided to add significant operational capabilities to our organization.

The venture capital business was a bit of a family business 25 years ago, where a few people basically made investment decisions, and that was it. Today, our organization is much more complex. We have a marketing team, a community team, and a talent organization that helps founders recruit. We also have a technology team inside Sequoia that can help us build the technology that we can leverage.

Business is becoming more and more complex. So the leader's job is to make sure the teams work together, which is similar to the leader's job in other organizations, but spends more time thinking about the people than the product.

Patrick: I like the point you made earlier that the main change is that founders have changed the scope of their ambitions. I wonder if the same applies to you and the company. Sequoia has a storied history. How do you see the significance of the brand?

RoelofFirst, let me talk about branding. In the 1970s, when almost every other professional services firm, law firm, accounting firm, etc., was putting the founder's name on the door, Don made a very deliberate decision to choose a redwood tree with thousands of years of life as his brand name because he wanted to build a partnership that would outlast him. When you do that, the people you recruit don't work for you, they work with you and inherit the business.

When recruited to Sequoia Capital, I had a feeling that if I was successful, I would be able to play a significant role in future partnerships. I didn't just join in to work for others and become their servant or lackey. We structured Sequoia as essentially a permanent partnership to the extent that the law allows, and we view Sequoia as a platform that gives us the ability to serve founders and LP. Our job is to put the partnership in a better shape.

And my job is to help Sequoia recruit the next generation of teams that will take over the partnership from the current leaders. Their job, in turn, will be to keep the sequoia platform growing.

This is our mission. Everything we do serves that purpose. This is what defines our ambition. This is our North Star.

How to Think about the world

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

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

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

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

Patrick: What's the biggest hurdle?

Roelof: Accurate measurement may be one of them. Partly because people don't have the right information to refer to, and partly because we don't internalize externalities. For example, ESG (Environment, Society and Governance), if we ignore these externalities and simply pursue profits, we do so 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 so that it can flourish.

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

RoelofMy undergraduate professors often quipped that accountants are trained to think about debts for one year, while actuaries try to think about the next 20 years. I didn't fully realize the value of that statement until I joined Sequoia. Because bad decisions are often made with a short-sighted perspective, it's hard to see the importance of compound interest, even though it didn't really help prehistoric humans. But when you think about how businesses grow, it's invaluable. Going back to the founding of Sequoia, people underestimated the ability of truly successful companies to compound consistently.

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

RoelofGenius to me is more about inspiration, talent is more about perspiration. 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 zero to one.

Patrick: I think you need both. That's probably the punch line.

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

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

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