Sequoia’s Roelof Botha: Why Venture Capital is Broken & How Great Companies Are Built

The Sequoia Scouts Program [1:30]

• The program was conceived in 2010 to enable contemporary founders with access to up-and-coming entrepreneurs to invest using the firm's capital.
• This allowed founders who didn't yet have the personal net worth to write large checks to participate in early-stage investing.
• The firm would receive introductions to these companies, allowing them to also make investments.
• Early participants included a founder who helped with the investment in Uber, and another who assisted with an investment in Stripe.
• At the time of the discussion, the fund associated with this program was a 26x fund.

This initiative recognized the value of leveraging the network and insights of successful founders to identify and invest in promising new ventures. It created a mutually beneficial relationship where founders gained investment experience and the firm gained access to exclusive deal flow.

You were in that program you helped us with the investment in Uber. Sam Alman was in that group as well. He helped with an investment in a little company called Stripe.

Venture Industry Dynamics and Capital Oversupply [3:40]

• The venture industry is characterized by specialization in stages and sectors, with constant experimentation in strategies.
• There is a significant problem of too much money in the venture industry, with an estimated $150 to $200 billion invested annually.
• With a reasonable assumed return of 12% per annum net, the math implies a need for 3.5x to 4x fund returns to make the numbers work.
• This means the industry needs to return $700-$800 billion annually, and with VCs not owning 100% of companies, the aggregate exit value needs to exceed $1 trillion annually.
• This is unachievable, as only about 20 companies per decade achieve exit values over $1 billion.

The speaker argues that the sheer volume of capital is distorting the market, making it difficult to achieve meaningful returns and turning venture investing into a "return-free risk." The fundamental issue is that more money does not create more great ideas or founders.

I think there is way too much money in the industry.

The Challenge of Capital Leveling and Repeatable Success [5:40]

• The problem of too much money in venture has persisted for 20 years, fueled by its perception as a "sexy asset class."
• Success stories, like a bestselling book by a scout, incentivize more people to enter the industry, creating a self-fulfilling prophecy.
• Firms with one success may attract more capital, leading investors to believe it's repeatable, which is often not the case.
• Many firms raise subsequent funds (fund three, four, five) before their initial funds are fully distributed.
• Transparency in returns is lacking, as most firms do not publicly share their performance data.

The dynamic of attracting capital based on isolated successes, without a clear understanding of repeatability, exacerbates the oversupply issue. The long gestation period for venture investments also contributes to the difficulty in accurately assessing performance and discouraging transparency.

So what could change for one one of the things that I thought was transparency but nobody wants to publish their returns.

Industrialization of Venture Capital and Firm Size [7:14]

• There has been an "industrialization" of venture capital, with firms building larger organizations and extensive operating teams.
• Examples include firms like General Catalyst, which have built broad operational support for entrepreneurs in areas like talent and go-to-market strategy.
• The firm has intentionally chosen not to build as large an organization, with a significant portion of their internal operating teams focused on building products to enhance their own effectiveness.
• This includes developers who build applications for investors, providing instant access to company data, meeting histories, ratings, hiring trends, and employee profiles.
• An AI system is used to summarize business plans, offering quick insights into the company, team quality, and competitive landscape.

This approach focuses on leveraging technology and internal resources to maintain efficiency and effectiveness, rather than scaling the organization in line with the broader trend of "industrialization" in the venture capital sector.

We've decided to not build as big an organization.

The China Market and Entrepreneurial Spirit [9:06]

• The firm had a significant business in China for two decades, starting around 2007, with an initial belief in a globally integrated economy.
• This premise proved incorrect, leading to increased division between the U.S. and China, making global integration too difficult.
• The firm embarked on a global separation over two years prior, with its China operations becoming an independent business called Hongchan.
• In China, there has been a dramatic decrease in company startups, from 51,000 in 2018 to 1,200 in 2023, a 98% reduction.
• This decline is attributed to government regulations and uncertainty, serving as a warning for AI policy and regulation in America.

Despite the challenges in China, the entrepreneurial spirit remains strong, with Chinese entrepreneurs now operating in Latin America, Singapore, Japan, and Europe, demonstrating resilience and adaptability.

The more uncertainty we create for founders, the more difficult it is for them to actually take that risk, take that leap to start a business.

Adapting to the Late-Stage Capital Dynamic [11:07]

• Early-stage venture firms have had strong track records, but late-stage firms face challenges funding companies requiring massive capital.
• This has led to direct investment from sovereign wealth funds in regions like Saudi Arabia, Qatar, the UAE, and Norway, which write very large checks.
• This creates a dynamic where firms can feel like glorified placement agents.
• The firm's strategy is to "stick to its knitting," maintaining the size of its seed, venture, and growth funds as they were several years ago.
• Their aspiration is to be the number one investment manager for their limited partners, focusing on delivering the best net IRR and net multiple, rather than maximizing fees.

The firm consciously avoids competing in the late-stage, large-check funding arena, opting instead to focus on its core strengths and commitment to its limited partners' returns.

But uh our aspiration is to be the number one investment manager for our limited partners.

The Firm's Structure and Stewardship [12:35]

• The firm is structured to be a private partnership in perpetuity, to the extent possible under California law.
• There is a strong sense of stewardship, with the mandate to leave the partnership in a better place than it was found.
• The firm's founder handed over the partnership to successive generations without charging the next generation, a motto that continues.
• There is no intention for the firm to go public or to seek external capital in a way that would alter its core strategy.

This commitment to a perpetual private partnership structure underscores a long-term vision and a dedication to preserving the firm's legacy and values across generations.

We have the sense of stewardship. You have to leave the partnership in a better place than you found it.

Culture: Curiosity, Drive, and Teamwork [13:08]

• The most important characteristic sought in partners is insatiable curiosity.
• Individuals must be extremely driven but also possess a "heart of gold."
• The firm cherishes individualism and teamwork; individuals need keen insight, but must collaborate effectively.
• Investment decisions are made by consensus, meaning every partner must agree for a deal to proceed.
• One partner can veto an investment, a process that weighs on individuals but ensures thorough consideration.

This cultural framework emphasizes a blend of individual brilliance and collective decision-making, fostering a rigorous and collaborative environment for investment evaluation.

We cherish individualism and teamwork.

The Consensus Decision-Making Process and Anti-Portfolio [13:47]

• Investment decisions are consensus-based, requiring unanimous agreement from all partners.
• If even one person disagrees, the investment does not happen.
• This veto power weighs on partners, requiring them to bring their best judgment to every decision.
• The firm analyzes vote distribution to identify outliers and address potential blind spots or disagreements.
• In one instance, a partner who was initially below the consensus line for a company later acknowledged their error and was glad the investment proceeded, highlighting the importance of individual conviction and collective wisdom.

The consensus model ensures that every partner's perspective is considered, preventing premature investments and fostering a culture of shared responsibility. It also acknowledges that even with consensus, individual insights can sometimes be overlooked, leading to a continuous learning process.

If one person says no it doesn't happen.

The Holding Company Transition and Long-Term Compounding [15:20]

• The biggest winners continue to compound value as public companies, with 99% of returns realized in this phase.
• True "compounders" can sustain growth for decades, especially with founders still actively involved.
• The firm launched the Sequoia Capital Fund in 2022 to hold companies that demonstrate long-term compounding potential, even after their IPO.
• This structure allows them to manage shares for 6-18 months post-IPO, moving them into this fund rather than prematurely distributing them to LPs.
• This strategy has already accumulated $6.7 billion in gains simply through patience, demonstrating the value of holding onto strong companies.

This innovative approach recognizes that IPO is not the end of value creation for exceptional companies and allows the firm to continue benefiting from their long-term growth.

The great companies continue to compound as you talked about in that episode.

The Argument for Post-IPO Involvement [18:22]

• The firm is involved with companies from their inception, sometimes incubating them within their offices.
• They question why this relationship should end at the IPO, especially when founders remain active and significant innovation continues.
• Founders often experience "multiple founding moments" where they reinvent the business.
• Companies like Square, with products like Cash App emerging years after launch, exemplify this continuous innovation.
• For companies where founders consistently push boundaries and demonstrate relentless innovation, maintaining a stake can be highly advantageous.

The firm believes its deep understanding of companies from their earliest stages provides a unique advantage in identifying and benefiting from their continued growth and reinvention post-IPO.

Why should that relationship end at the IPO?

Don Valentine's Founder Archetype [20:20]

• The founder created a 2x2 matrix to categorize founders based on their exceptionality and ease of getting along with.
• The most profitable quadrant for returns is "exceptional people who are not so easy to get along with."
• These individuals change the world, are highly driven, and do not accept "no" for an answer.
• This unconventional nature, as exemplified by figures like Steve Jobs who was once perceived as difficult, is seen as a key characteristic of world-changing founders.
• The advice is to look for unconventional founders who challenge norms, rather than those who fit conventional molds.

This framework suggests that true innovation often comes from individuals who possess intense drive and a unique perspective, even if it makes them challenging to work with in traditional settings.

The exceptional people who are not so easy to get along with.

Mentors: Doug Leone and Michael Moritz [22:21]

• From Doug Leone, the speaker learned about "heart," exemplified by Leone's unwavering support during difficult personal and professional times, including showing up at his house with homemade pesto and being present when his son was in the hospital.
• From Michael Moritz, the speaker gained an appreciation for "imagination," specifically the ability to envision a company's future success, even when early indicators are not promising.
• Moritz's foresight was evident in his early understanding of Twitter's potential beyond an SMS app and Yelp's future impact with stickers in restaurant windows, recognizing this potential years before it became reality.
• A personal mistake cited was a failure of imagination in not fully grasping the potential of Twitter and Yelp early on.

The lessons learned from these mentors highlight the dual importance of emotional intelligence and empathy (heart) alongside visionary thinking and strategic foresight (imagination) in the venture capital landscape.

Michael's imagination. Michael just has an unbelievable ability to imagine how a company can succeed.

Generational Transition and Knowledge Transfer [25:01]

• Succeeding legendary figures like Michael Moritz and Doug Leone is challenging, and everyone at the firm feels the burden of matching past performance.
• Michael Moritz stepped back from day-to-day activities in 2012 due to health reasons but remained on boards and provided advice for another decade.
• Doug Leone has also stepped back from daily investing but continues to serve on boards and is consulted for input on important decisions.
• The firm benefits from intergenerational knowledge transfer, with past leaders offering guidance.
• This process allows for a smooth transition while retaining the wisdom and experience of previous generations.

The firm has managed its leadership transition effectively, ensuring continuity and leveraging the experience of its former leaders through ongoing advisory roles.

So it's a we have this benefit of intergenerational uh knowledge transfer.

Life Sciences Investing and Nater [26:08]

• The firm has recently started investing in life sciences after years in traditional software and internet services.
• A successful investment is in Nater, a company that received a $1 million seed investment in 2007 and now has a $22 billion market cap.
• Nater is a leading provider of prenatal testing, oncology recurrence monitoring, and organ transplant projection testing.
• Diagnostics and genetic diagnostics have been significant success areas, benefiting from the progress of the human genome project.
• The firm also invested in Bridge Bio, focusing on rare genetic disease drug development.
• However, the firm acknowledges a lack of expertise in biotech, as they do not have MD PhDs on their team, and considers it dangerous to assume success in one domain translates to others.

While recognizing successes like Nater, the firm's limited expertise in biotech and other highly specialized scientific fields informs their cautious approach to further investments in that sector.

Diagnostics, genetic diagnostics, has been a huge success.