The Crucible Moment of Sequoia Capital

Compiled by: 0xtree/ Deep Tide TechFlow

Source: Patrick

Roelof Botha is a partner at Sequoia Capital, one of the oldest and most successful venture capital firms in the world. Recently, he announced that Sequoia Capital would undertake its boldest innovation since its founding in 1972—breaking the traditional 10-year investment cycle of VC and creating a permanently open structure under the name "Sequoia Fund."

The conversation delves into the details of Sequoia Capital's transformation, extending to Roelof Botha's entire career: including changes over the past 20 years, his days at PayPal, commonalities among legendary investor partners, and a retrospective on investments in companies like Square, YouTube, and Udemy.

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 traditional 10-year cycle prematurely ends the relationship between investors and investees.

3. A startup takes five years to achieve a value from 0 to 3, and five years later, as a public company, its cumulative total value is much higher.

4. One situation that might cause me to lose interest in an investment: the founder is a mercenary rather than a missionary. Mercenaries wilt in adversity.

5. Taking Square as an example, many companies have the potential for reinvention, but most organizations are their own biggest enemies, and many good ideas are often stifled within the organization.

6. The beauty of payments is that they help lubricate the wheels of business. Although it is an overused term, truly valuable things do make business easier.

7. I love the promise of smart contracts, where you can embed cryptocurrencies with payment activities, making transactions more seamless.

8. Certain DeFi technologies' promise in enabling smart contracts and reducing transaction costs is absolutely captivating.

9. The real risk of the metaverse is being controlled by large companies.

10. I think about what the three most important things that will happen with each company I work with in the next six months are. This helps you escape the distractions of immediate small matters.

11. When I was recruited to Sequoia Capital, I had a feeling that if I succeeded, I would be able to play an important role in future partnerships. I wasn't just joining to work for others, to be their servant or lackey.

12. Genius is more about inspiration, while 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 genius to go from 0 to 1.

1. Rewriting the VC Rulebook

Patrick: Can you talk about how you thought through this transformation? What problems does the new structure attempt to solve?

Roelof: Today's venture capital operating model was invented in the 1970s, primarily driven by the historical context of that time, and it has not changed for 50 years, which is somewhat regressive for disruptors looking to reshape industries through investment.

The problem with the traditional model lies in the closed 10-year fund. Traditional venture capital firms must strictly adhere to a 10-year fund duration, meaning that fund managers must sell their shares when the fund reaches its expiration in 10 to 12 years (the longest term).

When we examine existing businesses, we find that the lifespan of the cycle does not align with Sequoia's original intention to find special founders capable of building legendary companies that withstand the test of time.

For instance, in seed investments, we help founders find a market for their business model when they only have a rough idea and recruit the right execution team, and we continue to help them overcome the challenges on the road to success. We have all the background, relationships with founders, and the ability to help them continue to thrive.

But the default setting of the traditional 10-year cycle—namely, exiting the board and distributing shares shortly after the IPO—prematurely ends the relationship between investors and investees, forcing a misalignment of goals between startups and investment partners.

Why should an IPO be the destination for investors? I have worked for the growth of several companies for ten years or more. Why does an IPO mean that venture capitalists must exit the board?

Moreover, we realize that for these great companies, they will continue to compound, and most of the value accumulates after the IPO. So, if we consider it from the LP's perspective, at Sequoia, we work for what we call great causes. The vast majority of our LPs are endowment funds, foundations, and non-profit organizations. Our job is to create returns for them. So, since so many returns occur after a company goes public, why should we sell shares so quickly? Thus, the design of the Sequoia Fund is truly aimed at meeting two goals: helping founders have a more enduring capital base while helping LPs achieve better returns.

Patrick: Perhaps you could review the investment process in Square and use it as an example to illustrate the importance of the new structure, as Square is undoubtedly a very successful case based on real numbers.

Roelof: We began discussions with the company in 2010 and made an investment commitment, with the actual investment closing in January 2011, when the price per share was $0.95, and I was still a board member of the company. By the time Square went public, the IPO price was $9, yielding about 9 times the return. However, we chose to patiently distribute over the three to four years following the IPO, so the average sale price per share ended up being between $80 and $90, with a return rate of about 90 times. This patience had a huge impact on LP returns.

Looking back, Square had a total market value of $2.95 billion at the IPO. Five years after the IPO, the total value was $86 billion, and today it is valued at $115 to $120 billion.

In a sense, a startup takes five years to achieve a value from 0 to 3, and five years later, as a public company, its cumulative total value is much higher.

Patrick: Perhaps you could talk specifically about how the new structure will operate? Suppose I am a major LP at Sequoia. I have made some investments in each new fund or each fund that Sequoia launches. What will happen in the future?

Roelof: The background may be a bit complex. The funds we operate in the initial phase are clearly not launched within the Sequoia Fund.

In short, the restructured Sequoia Fund is an open fund with a liquid investment portfolio and is the first cross-fund that spans from seed-stage startups to publicly listed companies. The way this fund operates is by raising funds from limited partners (LPs) and then allocating these funds to a series of small closed sub-funds by stage, which can invest in the lifecycle of the investee companies (from seed to post-IPO) without an exit deadline, and the fund's returns will flow back to the Sequoia Fund, allowing Sequoia to hold shares for the long term.

In the new structure, Sequoia's limited partners (LPs) retain the right of repurchase and the right to allocate funds to sub-funds each year. After the companies in the portfolio go public, Sequoia will no longer distribute its shares to LPs but will allow investors to transfer their shares into this newly established Sequoia Fund with no expiration date, which will continue to be managed by Sequoia.

This fundamentally simplifies the complexity of capital calls for LPs, allowing them to better manage cash flow.

Then we provide LPs with the ability to redeem within the fund. The past distribution model had some issues in that it made an all-or-nothing decision for everyone. Once a distribution decision was made, everyone would receive their shares. Unfortunately, LPs often sell them when we distribute securities.

This makes sense. If you manage a $5 billion or $8 billion endowment fund and you receive shares in some new companies you don't know, and you don't have a stock trading desk, what else can you do? So, these securities would be attracted to the Sequoia Fund, but if you, as an LP, face liquidity constraints and need to fund some new educational initiatives or medical research, you can redeem part of your balance in the Sequoia Fund so that we can adjust liquidity based on everyone's needs.

Patrick: In summary, the main fund acts as a customizable tool for LPs, allowing them to decide where their dollars go, while also creating more liquidity and optionality at the backend, reducing the hassle of managing and redeeming funds, thus improving capital efficiency.

Roelof: Very true, but the most important thing is our judgment in holding these great projects for the long term and our ability to bring high returns to LPs, with Square being a prime example. Therefore, we need all the legal disclaimers because past performance does not guarantee future results.

Patrick: After the IPO, the stock is tied to the market every day, it is volatile, which is completely different from the traditional venture capital world. What are your thoughts on this change?

Roelof: In a sense, we have been very patient with distributions over the years. Currently, we hold $45 billion in public securities in our business in the U.S. and Europe, and I receive weekly reports on the dynamics of the portfolio being handled by the team. So, we have become accustomed to enduring this daily volatility.

The key is that we need to think differently, that is, we need to consider overall decision-making rather than distribution decisions, because selling or distributing is a very dangerous default. When you are fortunate enough to work with an outstanding team, you should have a different default setting.

Because the only way to achieve multiple returns is to work with founders who have incredible ambition and patiently allow them to continue to scale their businesses.

Patrick: What are some additional benefits of this new structure?

Roelof: The traditional investment community has operated under a set of regulations known as the VC exemption, which requires that no more than 20% of the fund can be invested in non-primary issued stocks. This means that bets on secondary markets, crypto markets, public securities, and fund-to-fund investments are all limited to 20% of the total fund size.

Many companies take years to go public, which somewhat limits the fund's capital flexibility. In 2001, eBay acquired PayPal, and at that time, we accepted continuous bids from eBay, and as a team, we also took a little money off the table to make the funds more flexible.

Over the years, we have supported some emerging managers, such as through the Scouts program (VC cavalry program), and we were the first to launch the Scouts program, but all similar ideas are constrained by the 20% VC exemption limit. This has forced us to reevaluate ourselves, and another point is in the investment in the crypto space; we have been active in crypto for five years and have achieved very good returns, but the same issue is that what I can do is limited under the current fund structure. The new structure may reasonably alleviate these restrictions.

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

Roelof: In our future seed venture growth fund, the fees remain unchanged. But now there is an additional capital flow pool, for which we have adopted a fee structure agreed upon by LPs, and its management fee is very low. I have also personally invested over a third of my net worth into the new product. I believe what is suitable for LPs is also suitable for us. By investing a significant amount of our own capital alongside our clients, we create a fee structure with wonderful incentives that only rewards us when investment performance exceeds a benchmark.

2. How the World is Changing

Patrick: From the perspective of founders, how do you view the evolving capital landscape?

Roelof: Global interest rates are so low. We see monetary and fiscal policies in massive recession due to COVID, and various types of assets have been affected, including venture capital.

In this environment, people have truly realized the scale effects brought by technological injection.

Twenty years ago, when I worked at PayPal, there were 200 million people on Earth who could access the internet. The vast majority of them were dial-up users. But look at the capabilities we have today; technology touches everyone and every industry, and if you create an effective company, it can attract a global audience and gain attention quickly, allowing your business to grow faster than ever. High growth naturally attracts more capital.

And entrepreneurs face the choice of when they need help, when they need business partners, and when they need transactional capital. Who to bring onto the board, who will help build the business? Are they suitable?

We recently met Jack Dorsey at a founder event, and he talked about how he returned 1% of the company's equity to Square twice. Not his own 1% equity, but the company's 1%, because he wanted to supplement the talent pool so that he could hire more great talent to help the company succeed. His insight was: "I want a small part of something that is truly successful and makes a significant impact, rather than hoarding as much equity as possible for myself." I think his approach has been very successful.

Patrick: How do you think today's landscape differs from the past? Or what is the current wave of change?

Roelof: One of the biggest changes I've noticed over the past 15 years is that founders have enough ambition, and when you see them accomplish something, it feels a bit like a scientific proof of existence. They can provide a reference template. Just like PayPal, which was once acquired for $1.5 billion, today it is a company valued at over $300 billion. Founders are more patient than ever, with global ambitions and a sense of mission. This is not only evident in the U.S. but is also beginning to manifest in Europe.

Patrick: What results might this change lead to?

Roelof: Not taking shortcuts, not using tape, trying to build things correctly; I see founders being more thoughtful about the composition of their management teams.

Take Square as an example. Square Cash did not exist in the first four or five years of the company's establishment. Today, it is a massive business with 10 million users. Jack once said: the company has multiple nodes of secondary innovation; how do you encourage the team to let creativity flourish within the organization and yield more results?

3. Roelof's Investment Framework

Patrick: When you first meet a founder or founding team, what is your goal? For example, what do you want to figure out?

Roelof: A difficult yet interesting question. Every meeting is a transaction, like a good interview. How to discover good questions and ask them in an engaging way, and how to build trust in communication is a delicate balance.

To be honest, discovering the questions themselves is very valuable. We want founders to look back at us and say, "You asked the toughest questions, and that's why I want to work with you, because you sharpen my thinking. You help me think about my business in different ways. That's the kind of thinking I want for the future."

I like to understand their Eureka moments. It is said that Archimedes had an epiphany while bathing and figured out how to measure the volume of a crown, exclaiming, "Eureka!"

I always want to figure out how the founder's inspiration and sense of mission occurred. For example, take the publicly listed company Natera, which specializes in bioinformatics and has world-leading non-invasive prenatal testing technology. I met the founder in high school; he has a PhD in electrical engineering from Stanford, and now he is doing everything he can to learn biology and genetics because he believes people need better care.

Because he found that in the 21st century, people do not have better technology to help families have healthy children. That is the motivation; it is mission-driven, and they may dedicate their lives to solving this problem.

Patrick: To what extent do you want to understand the potential business model or revenue model of a company in its early stages?

Roelof: This is almost nonexistent. I always think about value creation before capturing value. It is very rare for a company to create or provide tremendous value without establishing a good business. Now, to build a great company rather than just a good one, you need some originality in your business model.

Patrick: What situations might cause you to lose interest in a company early on?

Roelof: You can say no to every company; that is part of the challenge. Don Valentine once told us that our business is to invest, not to not invest.

For me personally, one situation that might cause me to lose interest is: the founder is a mercenary rather than a missionary. Because mercenaries wilt in adversity.

4. Square, YouTube, Unity, and MongoDB

Patrick: As a major investor and board member in Square, YouTube, Unity, and MongoDB, what experiences can you share?

Roelof: I have a deep understanding of the payments space, which is also part of why I am passionate about related investments. What is truly surprising is that Square was able to build a large consumer business, as the company's initial DNA was to serve small businesses.

This proves that the company has extraordinary secondary creation capabilities, which is essentially the ability to give life to new ideas. Because most organizations are their own biggest enemies, and many good ideas are often stifled within the organization.

Patrick: Looking back at the early days of PayPal, what was the most exciting aspect of future payments? What is interesting about today's payment landscape?

Roelof: The beauty of payments is that it helps lubricate the wheels of business. Although it is an overused term, truly valuable things do make business easier.

This is what we concluded after eBay acquired PayPal; there was a tight integration between PayPal and eBay's payment products, which accelerated business activities on eBay. This is the benefit that general payments can bring to the economy and GDP growth—making business easier.

I love the promise of smart contracts, where you can embed cryptocurrencies with payment activities, making transactions more seamless. Certain DeFi technologies' promise in enabling smart contracts and reducing transaction costs is absolutely captivating.

Patrick: This week's theme in business and markets is the metaverse, and Unity seems like a great opportunity. How do you see its role in the overall trend?

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

The difference between Unity and other products is that it fundamentally believes in an open ecosystem. Because in my view, the real risk of the metaverse is being controlled by large companies.

Patrick: Why can an open and decentralized approach have a positive impact?

Roelof: The downside of openness is interoperability. If things are very open, the pipelines between technologies can be fragile, and things may not work seamlessly. But this is a solvable technical challenge.

Unity can help solve this challenge, so when developers work on Unity, the games or applications 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 work across all different platforms.

As long as there are companies like Unity making this possible, you can leverage everyone's creativity. If it is a closed ecosystem, it becomes monopolistic, and monopolists do not need to innovate. Of course, the trade-off is whether the technology provides a good experience; otherwise, consumers will choose closed systems.

Patrick: What was your biggest takeaway from investing in YouTube?

Roelof: It was amazing to get involved early! Three founders are my friends and former colleagues from my PayPal days, and they came into Sequoia's office from Chad's garage in Menlo Park right from the start. Sequoia was their first office, and in the initial months, I worked with them every day, which was an incredible experience as we helped the company reach a critical mass.

In the early days, Chad, Steve, and Jawed discussed how YouTube could become a platform for creators. We also considered how to connect creators with brands to support them in their business activities, ultimately allowing them to make a living on YouTube. Now it has come true! So many people have a voice on it, which is unimaginable 25 years ago—how magical.

Patrick: Regarding MongoDB, which primarily targets developers, I am more interested in your views on the developer world.

Roelof: Over a decade ago, we had a strategic insight theme internally called the rise of developers. This informed our investment in Unity, as well as in developers, GitHub, MongoDB, Confluent, and many other businesses.

Currently, there are about 25 million people on Earth who make a living writing software, but the excellent products we use today rely on a very small number of people, so we need to help these developers create a multiplier effect with technologies or products that can enhance productivity.

5. Board Members, Legendary Investors, and Crucible Moments

Patrick: How do you ensure that you can help founders make pivotal turns at critical junctures?

Roelof: Sometimes a company may have one or several founders with product technical experience, but they have never built a sales team and need to go to market. You can bring in board members who excel in that area to help the company; they may not focus on critical junctures like I do, but they are very good at building sales teams and understanding go-to-market actions, which is functionally more targeted.

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

Patrick: Can you elaborate on how you enhance your ability to capture key moments? (Maintain accuracy)

Roelof: To be honest, one is experience, and the other is that after joining Sequoia, we received relevant training. The third is regular deep thinking, I think about what the three most important things that will happen with each company I work with in the next six months are. This helps you escape the distractions of immediate small matters.

Patrick: You just mentioned that board members represent different skills in the boardroom and have different utilities for the company. I believe the same answer applies to how to become great investors. You have worked with Mike Moritz, Doug Leone, Don Valentine, Jim Goetz, and many legendary investors. What do they have in common? What is the DNA of great investors?

Roelof: It is curiosity; it is the most important.

Of course, they may need analytical skills, judgment of people, intuition about market trends, etc. If you look at YouTube's memos, they are now public. Supporting three people with a product that has 9,000 registered users requires imagination. So you also need imagination. But most importantly, it is curiosity. Are you interested in learning new things? Are you interested in meeting new people? Are you interested in hearing their thoughts on a company and how they will change the world? If you lose that curiosity, you will become bored. Then, you might as well stop working as an investor.

Patrick: What makes an excellent investment memo?

Roelof: Clarity and conviction.

The ability to explain things clearly. I work with a person named Shankar Balasubramanian, who is a chemistry professor at Cambridge University. He invented the chemistry behind next-generation sequencing, and he founded a company called Solexa, which was acquired by Illumina, forming the backbone of next-generation sequencing products. He is absolutely a genius and a talented person. He has the ability to explain extremely complex topics in a way that I can understand. That is a gift for me; when you can clearly summarize complex businesses and technologies, anyone can read and understand it. For me, that means you have mastered it.

Many people have good analytical skills; they can tell you. On the other hand, our business is about making decisions, and there is always uncertainty, so you must make calls when things are unclear. Therefore, you need that conviction, that willingness to stick your neck out and make recommendations.

Patrick: Around 2017, you took on additional responsibilities to oversee Sequoia's franchise in the U.S. I know you have been a driving force behind significant changes in how they operate in the U.S. How do you view the skills needed to complete that work, and how does it differ from the traditional role of a general partner or pure investor?

Roelof: I started to think more about assembling the team. Do we have the right genes? Do we have the right candidates? Is their work harmonious? Are we collaborating well? We have an early team and a growth team; how do we ensure there is a wonderful chemical reaction between them? As a company, 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, basically making investment decisions by a handful of people, and that was it. Today, our organization is much more complex. We have a marketing team, a community team, and a talent organization to help founders recruit. We also have a technology team within Sequoia to help us build technologies we can leverage.

The business has become increasingly complex. Therefore, the leader's job is to ensure collaboration among teams, which is similar to the work of leaders in other organizations; it requires spending more time considering people issues rather than product issues.

Patrick: I love your earlier point that the main change is that founders have changed the scope of their ambitions. I am curious if this applies to you and the company as well. Sequoia has a legendary history; how do you view the significance of this brand?

Roelof: First, let me talk about the brand issue. In the 1970s, when almost all other professional service firms, law firms, accounting firms, etc., put the founders' names on the door, Don made a very careful decision to choose the Sequoia tree, which has thousands of years of life, as the brand name because he wanted to establish a partnership that would outlast him. When you do this, the people you recruit do not work for you; they work with you and inherit the business.

When I was recruited to Sequoia Capital, I had a feeling that if I succeeded, I would be able to play an important role in future partnerships. I wasn't just joining to work for others, to be their servant or lackey. We built Sequoia as essentially a permanent partnership within the legal limits, and we view Sequoia as a platform that provides us with the ability to serve founders and LPs. Our job is to keep the partnership in a better state.

And my job is to help Sequoia recruit the next generation of teams who will take over the partnerships of the existing leaders. In turn, their responsibility will be to continue to grow the Sequoia platform.

This is our mission. Everything we do serves this purpose. This defines our ambition; this is our North Star.

6. How to Think About the World

Patrick: Returning to the point about curiosity, what set of trends are you most curious about in today's world?

Roelof: Genetic engineering. I am fascinated by it, and with all the capabilities of genetic engineering we are inventing, the development of precision genetic engineering is crucial for the future of the world.

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

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

Patrick: What are the biggest obstacles?

Roelof: Accurate measurement may be one of them. On one hand, people do not have the correct information to reference, and on the other hand, we do not internalize externalities. For example, ESG (Environmental, Social, and Governance); if we do not consider these externalities and purely 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 sound institutions to improve it and allow it to thrive.

Patrick: At the beginning of your career, you were an actuary. How has this profession influenced your later investment experiences?

Roelof: My professor during my undergraduate studies often joked that accountants are trained to think one year ahead, while actuaries try to think 20 years ahead. It wasn't until I joined Sequoia that I fully realized the value of this statement. Because making poor decisions is often due to a short-sighted perspective that overlooks the importance of compounding. Although compounding didn't really help prehistoric humans, when you consider how businesses grow, it becomes extremely valuable. Going back to the founding of the Sequoia Fund, people actually underestimated the sustained compounding ability of truly successful companies.

Patrick: What is the difference between talent and genius?

Roelof: For me, genius is more about inspiration, while 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 genius to go from 0 to 1.

Patrick: I think you need both. That might be the key point.

Roelof: I don't like to overly emphasize any specific attribute of either side. Just like playing football, part of the charm of football is that it is a complete team sport. And there is no measurement of individual metrics. No one walks off the football field saying, "Oh, I made five passes, or I ran a hundred yards." It is just, did we win as a team? You don't even calculate whether you passed to a teammate who scored. What matters is that we made the attempt and won as a team.

When I consider building a business, this kind of complementarity is also needed; you need to respect and appreciate the different talents people bring, not just praise the quarterback.