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Adapting Episode 2: Sequoia’s Black Swan Memo (with Roelof Botha)

Season 6, Episode 5

Limited Partner Episode

March 30, 2020
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On March 5th 2020, Sequoia Capital published a Medium post entitled ‘Coronavirus: The Black Swan of 2020’. The memo minces no words, admonishing founders & CEOs to “question every assumption about your business”, and portends that “as Darwin surmised, those who [will] survive ‘are not the strongest or the most intelligent, but the most adaptable to change.’” We’re joined by longtime Sequoia partner and head of the firm’s US business Roelof Botha to discuss on what Sequoia saw leading up to the memo and why they decided to publish it, how they and their portfolio companies are adapting to the new world it warned of, and what lasting changes might come to Sequoia itself from this moment. For anyone facing hard decisions and/or looking for ways to think about opportunity, this is not one to miss.


Want more Adapting/Acquired? You can join the Acquired Limited Partner program at: https://glow.fm/acquired/


Links:


Sponsor:

  • Thanks to Silicon Valley Bank for being our banner sponsor for Adapting and Acquired Season 6. You can learn more about SVB here: https://www.svb.com/next
  • Thank you as well to Wilson Sonsini - You can learn more about WSGR at: https://www.wsgr.com/

We finally did it. After five years and over 100 episodes, we decided to formalize the answer to Acquired’s most frequently asked question: “what are the best acquisitions of all time?” Here it is: The Acquired Top Ten. You can listen to the full episode (above, which includes honorable mentions), or read our quick blog post below.

Note: we ranked the list by our estimate of absolute dollar return to the acquirer. We could have used ROI multiple or annualized return, but we decided the ultimate yardstick of success should be the absolute dollar amount added to the parent company’s enterprise value. Afterall, you can’t eat IRR! For more on our methodology, please see the notes at the end of this post. And for all our trademark Acquired editorial and discussion tune in to the full episode above!

10. Marvel

Purchase Price: $4.2 billion, 2009

Estimated Current Contribution to Market Cap: $20.5 billion

Absolute Dollar Return: $16.3 billion

Back in 2009, Marvel Studios was recently formed, most of its movie rights were leased out, and the prevailing wisdom was that Marvel was just some old comic book IP company that only nerds cared about. Since then, Marvel Cinematic Universe films have grossed $22.5b in total box office receipts (including the single biggest movie of all-time), for an average of $2.2b annually. Disney earns about two dollars in parks and merchandise revenue for every one dollar earned from films (discussed on our Disney, Plus episode). Therefore we estimate Marvel generates about $6.75b in annual revenue for Disney, or nearly 10% of all the company’s revenue. Not bad for a set of nerdy comic book franchises…

Marvel
Season 1, Episode 26
LP Show
1/5/2016

9. Google Maps (Where2, Keyhole, ZipDash)

Total Purchase Price: $70 million (estimated), 2004

Estimated Current Contribution to Market Cap: $16.9 billion

Absolute Dollar Return: $16.8 billion

Morgan Stanley estimated that Google Maps generated $2.95b in revenue in 2019. Although that’s small compared to Google’s overall revenue of $160b+, it still accounts for over $16b in market cap by our calculations. Ironically the majority of Maps’ usage (and presumably revenue) comes from mobile, which grew out of by far the smallest of the 3 acquisitions, ZipDash. Tiny yet mighty!

Google Maps
Season 5, Episode 3
LP Show
8/28/2019

8. ESPN

Total Purchase Price: $188 million (by ABC), 1984

Estimated Current Contribution to Market Cap: $31.2 billion

Absolute Dollar Return: $31.0 billion

ABC’s 1984 acquisition of ESPN is heavyweight champion and still undisputed G.O.A.T. of media acquisitions.With an estimated $10.3B in 2018 revenue, ESPN’s value has compounded annually within ABC/Disney at >15% for an astounding THIRTY-FIVE YEARS. Single-handedly responsible for one of the greatest business model innovations in history with the advent of cable carriage fees, ESPN proves Albert Einstein’s famous statement that “Compound interest is the eighth wonder of the world.”

ESPN
Season 4, Episode 1
LP Show
1/28/2019

7. PayPal

Total Purchase Price: $1.5 billion, 2002

Value Realized at Spinoff: $47.1 billion

Absolute Dollar Return: $45.6 billion

Who would have thought facilitating payments for Beanie Baby trades could be so lucrative? The only acquisition on our list whose value we can precisely measure, eBay spun off PayPal into a stand-alone public company in July 2015. Its value at the time? A cool 31x what eBay paid in 2002.

PayPal
Season 1, Episode 11
LP Show
5/8/2016

6. Booking.com

Total Purchase Price: $135 million, 2005

Estimated Current Contribution to Market Cap: $49.9 billion

Absolute Dollar Return: $49.8 billion

Remember the Priceline Negotiator? Boy did he get himself a screaming deal on this one. This purchase might have ranked even higher if Booking Holdings’ stock (Priceline even renamed the whole company after this acquisition!) weren’t down ~20% due to COVID-19 fears when we did the analysis. We also took a conservative approach, using only the (massive) $10.8b in annual revenue from the company’s “Agency Revenues” segment as Booking.com’s contribution — there is likely more revenue in other segments that’s also attributable to Booking.com, though we can’t be sure how much.

Booking.com (with Jetsetter & Room 77 CEO Drew Patterson)
Season 1, Episode 41
LP Show
6/25/2017

5. NeXT

Total Purchase Price: $429 million, 1997

Estimated Current Contribution to Market Cap: $63.0 billion

Absolute Dollar Return: $62.6 billion

How do you put a value on Steve Jobs? Turns out we didn’t have to! NeXTSTEP, NeXT’s operating system, underpins all of Apple’s modern operating systems today: MacOS, iOS, WatchOS, and beyond. Literally every dollar of Apple’s $260b in annual revenue comes from NeXT roots, and from Steve wiping the product slate clean upon his return. With the acquisition being necessary but not sufficient to create Apple’s $1.4 trillion market cap today, we conservatively attributed 5% of Apple to this purchase.

NeXT
Season 1, Episode 23
LP Show
10/23/2016

4. Android

Total Purchase Price: $50 million, 2005

Estimated Current Contribution to Market Cap: $72 billion

Absolute Dollar Return: $72 billion

Speaking of operating system acquisitions, NeXT was great, but on a pure value basis Android beats it. We took Google Play Store revenues (where Google’s 30% cut is worth about $7.7b) and added the dollar amount we estimate Google saves in Traffic Acquisition Costs by owning default search on Android ($4.8b), to reach an estimated annual revenue contribution to Google of $12.5b from the diminutive robot OS. Android also takes the award for largest ROI multiple: >1400x. Yep, you can’t eat IRR, but that’s a figure VCs only dream of.

Android
Season 1, Episode 20
LP Show
9/16/2016

3. YouTube

Total Purchase Price: $1.65 billion, 2006

Estimated Current Contribution to Market Cap: $86.2 billion

Absolute Dollar Return: $84.5 billion

We admit it, we screwed up on our first episode covering YouTube: there’s no way this deal was a “C”.  With Google recently reporting YouTube revenues for the first time ($15b — almost 10% of Google’s revenue!), it’s clear this acquisition was a juggernaut. It’s past-time for an Acquired revisit.

That said, while YouTube as the world’s second-highest-traffic search engine (second-only to their parent company!) grosses $15b, much of that revenue (over 50%?) gets paid out to creators, and YouTube’s hosting and bandwidth costs are significant. But we’ll leave the debate over the division’s profitability to the podcast.

YouTube
Season 1, Episode 7
LP Show
2/3/2016

2. DoubleClick

Total Purchase Price: $3.1 billion, 2007

Estimated Current Contribution to Market Cap: $126.4 billion

Absolute Dollar Return: $123.3 billion

A dark horse rides into second place! The only acquisition on this list not-yet covered on Acquired (to be remedied very soon), this deal was far, far more important than most people realize. Effectively extending Google’s advertising reach from just its own properties to the entire internet, DoubleClick and its associated products generated over $20b in revenue within Google last year. Given what we now know about the nature of competition in internet advertising services, it’s unlikely governments and antitrust authorities would allow another deal like this again, much like #1 on our list...

1. Instagram

Purchase Price: $1 billion, 2012

Estimated Current Contribution to Market Cap: $153 billion

Absolute Dollar Return: $152 billion

Source: SportsNation

When it comes to G.O.A.T. status, if ESPN is M&A’s Lebron, Insta is its MJ. No offense to ESPN/Lebron, but we’ll probably never see another acquisition that’s so unquestionably dominant across every dimension of the M&A game as Facebook’s 2012 purchase of Instagram. Reported by Bloomberg to be doing $20B of revenue annually now within Facebook (up from ~$0 just eight years ago), Instagram takes the Acquired crown by a mile. And unlike YouTube, Facebook keeps nearly all of that $20b for itself! At risk of stretching the MJ analogy too far, given the circumstances at the time of the deal — Facebook’s “missing” of mobile and existential questions surrounding its ill-fated IPO — buying Instagram was Facebook’s equivalent of Jordan’s Game 6. Whether this deal was ultimately good or bad for the world at-large is another question, but there’s no doubt Instagram goes down in history as the greatest acquisition of all-time.

Instagram
Season 1, Episode 2
LP Show
10/31/2015

The Acquired Top Ten data, in full.

Methodology and Notes:

  • In order to count for our list, acquisitions must be at least a majority stake in the target company (otherwise it’s just an investment). Naspers’ investment in Tencent and Softbank/Yahoo’s investment in Alibaba are disqualified for this reason.
  • We considered all historical acquisitions — not just technology companies — but may have overlooked some in areas that we know less well. If you have any examples you think we missed ping us on Slack or email at: acquiredfm@gmail.com
  • We used revenue multiples to estimate the current value of the acquired company, multiplying its current estimated revenue by the market cap-to-revenue multiple of the parent company’s stock. We recognize this analysis is flawed (cashflow/profit multiples are better, at least for mature companies), but given the opacity of most companies’ business unit reporting, this was the only way to apply a consistent and straightforward approach to each deal.
  • All underlying assumptions are based on public financial disclosures unless stated otherwise. If we made an assumption not disclosed by the parent company, we linked to the source of the reported assumption.
  • This ranking represents a point in time in history, March 2, 2020. It is obviously subject to change going forward from both future and past acquisition performance, as well as fluctuating stock prices.
  • We have five honorable mentions that didn’t make our Top Ten list. Tune into the full episode to hear them!

Sponsor:

  • Thanks to Silicon Valley Bank for being our banner sponsor for Acquired Season 6. You can learn more about SVB here: https://www.svb.com/next
  • Thank you as well to Wilson Sonsini - You can learn more about WSGR at: https://www.wsgr.com/

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Transcript: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

Ben: Welcome to Episode Two of Adapting by Acquired.

David: Now you've got it.

Ben: I rehearsed. For those keeping track at home, Season Six, Episode Five. We are continuing our series to bring you the stories of great companies and great leaders who are adapting to a world that's changing in real time. Today, we are covering the story behind the memo read around the world, Sequoia Capital’s Black Swan memo, Amazingly published only 20 days ago as we record this.

David: Feels like 20 lifetimes ago.

Ben: I know. We are joined by the best person in the world to tell us about it. Long time Sequoia partner, Roelof Botha. Today's episode is different from last week's episode with Canlis. We are going much closer to Acquired’s bread and butter of technology and venture capital.

This conversation is particularly interesting not just to hear the story behind the Black Swan memo, but also to get a real time look at how Sequoia themselves are thinking about adapting during this time along with their portfolio companies.

David: Before we jump in, if you haven't already, we want to strongly encourage you to join the Acquired Slack community. I honestly think at this point, it's probably the best community on the internet for people focused on building and investing in great companies. We really mean that and that's a testament to you all.

The quality of people that listen to this show. It's been pretty awesome especially for the last week or so just seeing how we're all supporting each other in there and helping everybody get through at this time. You can find the link on our website to get an invite. You should definitely sign up.

The other thing we want to tell you about is as we announced in the last episode, we are adding something big to the limited partner program that we're really excited about. We're going to be hosting monthly calls on Zoom for all LPs which we're calling, appropriately enough, LP calls.

Ben: Very original, David.

David: Yes, super original. We're big in the branding here at Acquired. When you sign up for the limited partner program, you get both our LP episodes, which go deeper on nitty gritty company building topics, and access to the monthly LP calls to the both of us. You can sign up by clicking the links on the show notes or going to glow.fm/acquired.

Ben: As always, we want to thank our sponsor for all of Season Six, and Adapting, Silicon Valley Bank. Innovation happens when the status quo just won't do. As the world fights COVID-19, Silicon Valley Bank pays tribute to all of the innovators, health care providers and scientists, social workers, take out chefs, policy makers, and philanthropists. Generous driven individuals working around the clock to keep people alive, find a cure, and help the world cope with the unimaginable.

SVB supports innovative companies and their investors and have for more than 35 years. It knows that innovation requires adaptability, flexibility, and unrelenting passion for finding solutions.

Today, more than ever, SVB salutes innovators everywhere. You can learn more at svb.com/next, thanks to SVB. With that, David, we will dive in with our interview with Roelof.

David: We are super lucky to have Roelof with us today. Roelof has been a partner at Sequoia since 2003 and led early investments in some of the most important companies that we've covered on this show. Companies like Instagram, YouTube, and Square. He currently leads the firm's US business as one of Sequioa's three stewards along with Doug Leone and Neil Shen.

Prior to joining Sequoia, Roelof was the CFO of PayPal which is particularly relevant to our conversation today, having helped navigate them through the dot-com crash, their subsequent IPO, and ultimately sold Ebay for $1.5 billion. Welcome, Roelof, and thanks for joining us in these interesting times.

Roelof: Thank you. I wish the circumstances were different, but I'm glad to be here.

David: Us too, we're glad to have you. Let's jump right into it. On March 5th, you guys did something that now seems obvious in hindsight but definitely did not seem obvious on March 5th.

Ben: I think March 5th was two years ago at this point.

David: It feels like there's a Lennon quote that people have been saying about some decades nothing happens, and some weeks decades happen. It's been about two decades. You guys released publically, both simultaneously, emailed all your portfolio CEOs and posted on Medium what you called the Black Swan Memo. I'm sure most of our listeners have read it probably a multiple times at this point.

I just want to point out, I just want to highlight one quote from it that again probably everyone's read, but it's such a stark difference between what you guys said and what so many other investors and people were saying at the moment. You said, “Having weathered every business downturn for nearly 50 years, we've learned an important lesson. Nobody ever regrets making fast, decisive adjustments to changing circumstances. In downturns, revenue, and cash levels always fall faster than expenses. In some ways, business mirrors biology. As Darwin surmised, those who survive are not the strongest or the most intelligent, but the most adaptable to change.” Can you walk us through as you were writing this and getting ready to hit publish, what were you feeling internally?

Roelof: The sense of nervousness that the world wasn't really paying attention to the reality that we were facing. We have the benefit of being a global partnership so we were seeing what was happening in China with our business, and with our partners, and what it was like to be under a lockdown. We've been through many business cycles that took way. We've been around for 48 years. We've been through so many of these cycles and we've seen this movie before, and our sense was that people hadn't quite realized what was about to happen. It was like watching an accident happen in slow motion. You can just see it and we felt a duty and obligation to do something about it.

Ben: Let's set the stage for folks. This was six days before the NBA announcement came out, so it was a week before the general American consciousness woke up and said, “Oh my god, this is a huge deal.” Did you worry at all that you were jumping the gun? And as a related question, Sequoia is such a force in our ecosystem. Did you think about the risk of, “Gosh do we incite something by releasing something like this?”

Roelof: We do, which is why we do this very infrequently. The last time we did something comparable was at the end of 2008 with the RIP Good Times memo which wasn't intended to be published. It was really intended just for our founders because we wanted them to understand what was happening, and it comes at a risk. I heard from people back in 2008 that we were the reason the crash happened, as if we had that kind of power.

I heard people complain we were being alarmists and things like that. We really felt a duty that maybe people are going to be uncomfortable with us saying these sort of things, wut we have an obligation to tell people what we see coming around the corner. Someone challenged me and said, “Well what if it doesn't turn out to be that bad?” And I said, “If that's the case, I'd be so thankful and I will eat humble pie for having published this.” There's so much more important for us to put the word of warning out.

Often when you're in the trenches as a company, you have a slightly different perspective on things, especially if you haven't been through previous cycles. I remember when I was there in PayPal, and I joined in March of 2000, the NASDAQ saw it slide in April. I remember being at a board meeting with Michael Moritz from Sequoia in June, and he told us he wanted us to focus on runway because the financing environment has changed forever. I think honestly, for all of us as first timers if you will in the company, we didn't quite fathom that. We thought that  what we'd experienced for the last two years would continue, and he really rang the bell and we paid attention. That month, we really started to sharpen our pencils to make sure that we had enough runway to make it to the other side.

David: I'm super curious. You've talked about this a bunch and obviously a CFO, you were right there at the helm doing this. What were the things you did? You were I believe the first technology company to go public after the crash then had this wonderful exit. What were the actual things that you did to save the company and to stay on a growth trajectory even through all this carnage?

Roelof: This is obviously a team effort. I was one of many people in the company that rallied together and I think that's one of the things that you see in this unfortunate humanitarian crisis. I think the thing that's different about this by the way is it's a health crisis in addition to an economic crisis at a global scale. That makes it so different from any of these other incidents we've seen. That's awful on many levels, but I do think it's very different from what we had back then.

But we rallied as a team and we looked through the P&L. I remember literally going through line by line on every single thing on which we were spending money to figure out what was truly essential to helping us build a successful business. On the expense line, the things that you can control.

We tried furiously to raise more money to extend our runway, and we got religion about our business model. Up until I think June 10 or June 20 2000, PayPal didn't charge for its service. At that point, we realized if we wanted to keep going, we had to figure out a business model and make it a great business model. That's exactly the kind of focus that we got because the external environment changed so dramatically.

Constraints enable you to come up with creative new solutions. I think you're going to find an incredible array of entrepreneurs coming up with wonderful solutions in the midst of this terrible crisis.

David: To go back for a sec to the Black Swan memo, can you talk a little bit about what it was over the preceding weeks before March 5th that you were seeing in China? And obviously through your unique perspective that gave you confidence that, “Hey this is a lot more serious than people are realizing in the US and elsewhere?

Roelof: I think we saw our team in China immediately had to go into a full lockdown. A dramatic change at a national level with over a billion people, and not just in the province that was affected, but everywhere. They were taking it seriously. Clearly the people at the frontlines had seen that this was a virus unlike others that were spreading a lot faster and had higher mortality rate than a typical seasonal flu. That just felt very, very different.

I think it was pretty obvious that by then there were cases showing up in the US. Even though there was a travel ban at one point, it was just too porous. People could have come in from mainland China, they could have gone to other parts of the world and come into the US. It was quite likely that there's a bigger problem today in the US than we realized, and this is the unfortunate thing about the absence of testing infrastructure right now in the country.

I have a friend in New York who had it for 11 days before he was confirmed positive last week. My brother in San Francisco, I think he has it but he can't get tested. He literally can't get tested because he is not in a high risk group. I think that we just had a sense that the problem was actually a lot bigger.

There's the parable of the wheat or the rice and the chessboard where the person wants to get compensated one, two, four etc. and it's obviously a great thing for people to study computer science. But teach to the bar and become a very large number as gross and things that grow exponentially, we just don't understand it.

Something that looked trivial 12 days ago but it's doubling every six days suddenly looks dramatically different. Just two weeks later and I think we saw that this was at the cusp of happening in America. We felt this obligation, like I said earlier, to make sure that people paid attention and acted now.

Ben: That's a great lead into something that David and I talk about a lot. David, I don't think I have shared this with you, but I look up to you a lot in the way that you think about playing defense, and playing offense, and being very careful about when is the time for defense and when is the time for our offense. Doing both at the same time, you just have to be careful what actions are for which thing and rule off.

I want to dive in on defense right now. You guys have been putting out a reasonable amount of content compared to Sequoia of old, and one of the pieces that you publish for entrepreneurs is this decision matrix. I would think about this as defense. How should entrepreneurs use that? And then I'm curious to ask you some questions about offense.

Roelof: I want to give credit to one of our CFOs in the portfolio. He doesn't want to be singled out to name but he developed this for a portfolio company where I happened to be on the board for Sequoia. I thought it was an incredible structure. In that case the company had seven main scenarios with a couple of sub scenarios, and I just thought it's a wonderful framework to address the challenge you face because we don't know the state of the world.

There's so much uncertainty right now but are we actually going to reopen in 3 weeks, 4 weeks, 10 weeks? Is there going to be a second wave? Are there going to be five waves? Is the world going to be in [...]? We don't know.

I thought it was a wonderful way to think about what are the various scenarios that may play out? What are the strategies you could pursue? And what does it do for your resulting cash balance at some future date that is important? Your end is as good as any I guess at this point. Because companies need to survive.

Cash is the most important thing companies have to focus on right now because if you don't survive, obviously there's no chance for you to build an enduring business. That's the reason I thought it was a fabulous framework. Again, we felt we wanted it to be shared with as many people as possible, and we did actually. On Friday we had a Q&A session with over 100 portfolio companies. Several of our partners hosted this call. We shared with those companies and we just told them that we wanted to share with everybody.

Ben: To ask the question on offense, this time is incredibly challenging for a lot of people and we should in no way gloss over that. I'm sure it's challenging for you, it's challenging for me. Yet, you can squint and find ways to actually turn it into something positive, and find perhaps a dislocation in a market, or an opportunity that's emerged that was never a need from people before. I’d just love to get your perspective on how people can be proactive and turn this into a positive?

Roelof: There are a couple of companies obviously that benefit from us all having to work from home and things like that. The product we're using, Zoom, is obviously benefiting companies, like Loom in our portfolio that are benefiting. The delivery companies are an essential service in my mind to make sure that we get food and get delivery of basic necessities. There's a class of companies that are benefiting. You may not be one of those companies so that doesn't really help you.

The thing that I think really everybody can focus on at this time is product development. Keep on investing in your product. Sales and marketing by definition are going to be challenged over the next few months because people are going to shift their consumption behavior. Face to face selling if you're an enterprise company is going to be hampered. Marketing channels may be flooded by the things, and it may seem insensitive candidly for you to peddle certain types of products right now. It's just not the right time.

Hunker down and focus on product development. Build that truly differentiated product that if you can survive, gives you a huge advantage when you come out the other side. Part of what happens here and I'll use the analogy of us namesake Sequoia tree, forest fires have been a part of the landscape in the US for a long time and it'll often clear the brush. The sequoia trees that survive end up thriving disproportionately once the fire has cleared, because there's more sunlight and there's more space for those that survive. You've got to wait your time out and make sure that you can pounce with a truly differentiated product, because the competitive landscape is probably going to be clear for you after that.

I think the other thing to do before is to look for a community. It's a lot of what we've been doing. Trying to get our founders together not only with the sort of weekly call that we're doing now but founding communities together. There's so much ingenuity and so much good advice and tips that they can share with each other, and also just kindred spirits where they can share some of the suffering candidly that's happening right now. Lean into community, lean into your product.

David: I know you guys have done some innovative things for creating spaces right now for your portfolio companies. How are you doing that? How are you interacting with them, and then with each other?

Roelof: At an individual level, obviously board members are in frequent contact with their companies as we try to share best practices. In addition to the Matrix which we shared publicly, there are a couple of other things that we've prepared for companies, for the unfortunate company that may need to go through a reduction in force for example.

We've actually prepared some best practices that we've seen to share with people and just help them for some of the challenges that lie ahead. We've created the Q&A with us as a group so we get over a hundred companies to get together with Sequoia partners and we have a few prepared remarks, things that we're seeing and we open it up for questions.

We're arranging founder to founder sessions. Sequoia people present industries that are relevant where they can share best practices. We're also doing that for CFOs. We think a lot of the CFO across the portfolio are dealing with similar challenges. What do they do about potential rent abatement? What will they do to renegotiate debt? What happened to that financing that was supposed to close? Things like that where they can also get together and help each other.

If anything this has also accelerated our desire to build even more digital products around our community. We've prided ourselves in the community things we do with activities like Basecamp, and other programs we have. Obviously those are halted right now. What can we do to recreate as much of that as possible online is something we're working on.

David: Can we circle back real quick before we get off playing offense for portfolio companies. I want to come back to your time at PayPal. It struck me that I didn't realize that PayPal didn't have a business model or at least a viable business model until after the crash. As I think about the hierarchy of impacts of change you can have as a startup, they're at the bottom of sales and marketing and then nothing sales marketing. Then at the mid-level as a product but actually the highest level I always think is changing a business model. Now is a really good opportunity to do that. What did you guys think about, there was the necessity of, “Okay you need to make revenue now,” but how did you figure out that business model so quickly during that time of PayPal?

Roelof: Necessity is the mother of invention. I don't think it was that difficult to figure out that as a payments company, there were so many precedents of charging transaction based fees. I think there were some other nuances where we figured out how to get bank account funding so that we had a much higher gross margin than traditional credit card processors did. There's some other things we did.

We also had to figure out solutions to online fraud which took down many of our competitors and was a very expensive thing for us as well. We lost millions of dollars in 2000 to scalable online fraud. Part of what we talked about at the company was at the end of the day, if we can't keep the company alive because people are willing to pay for the service we provide. We don't really have a reason to exist. But we need to deliver enough value so that whatever we charge leaves enough of a gap of value capture to the customer where they're happy to pay for the service we have.

I think many companies may face that type of a crucible moment over the next six months if they've been free services or if their business model hasn't really been refined properly, but it's clarifying at some level.

Ben: Were you really forced to show up in a way that says, “Hey I am delivering enough value here to charge for it.” What's the quote about, is it a Warren Buffett quote? ‘Who has their shorts on when the tide goes out.’

David: I think it might be Howard Marks actually.

Ben: Is it? Okay.

Roelof: I'll give you another one that we used actually this week in a partnership which is, “Calm seas never made a good sailor.”

David: And we've got a long period of calm seas.

Roelof: We have and this is going to be a time where I think you're really going to see people differentiate themselves and how they deal with the crisis. Who steps up? Who provides leadership? Who reminds a company of the mission of the company, the purpose that they have beyond just delivering a product? Those are the companies that I think can really excel in a time of crisis.

Ben: I want to move us along to a section here that we're doing in Adapting called Adapting, and really talk about Sequoia itself and how you're adapting. I remember when we interviewed Doug, he spoke of the war room days of managing the 1999 fund after the dot-com crash. What does the Sequoia war room of March 2020 look like, especially as you literally can't be in a war room?

Roelof: The virtual war room. The other thing which is challenging is we have our by-annual LP meeting next week. Just for context, it was originally supposed to be in India, and then in January we started to worry given what we were seeing in China. We actually moved it in January from India to California because we thought there were going to be issues in this early April late March timeframe.

Just concretely, we took action and then obviously having it in California started to not look feasible so we moved it to a virtual LP meeting. In the midst of preparing for a very important event for us. Our LPs are our customers and we want to have a great show for them in some sense, and provide candid feedback, and reporting on our funds. At the same time we're running around like crazy looking after our portfolio companies.

The most important thing we've focused on over the last two weeks is our companies. Sequoia, as a business we've been around for almost five decades. We're not in a tough spot fortunately but some of our companies really do face challenges. We've really oriented everything towards what is best for our companies. We've built a bunch of online tools. We have resources where we can all look at things. We have daily stand ups using Zoom so that we can already stay in touch. We understand what the prioritization is.

Ben: And that's among the partnership?

Roelof: Within the partnership. As a team,  what do you do to mimic the effect of being in an office together. We just stay in touch a little bit more frequently, and we've created these online resources, and probably the most important thing we've done is to do a very thorough analysis of the portfolio health. Literally company by company across every single company in the US, we've gone down to figure out, “Okay at your end in December, what was the expected run by based on cash? And by then what do we think it is now given the changed circumstances? And which are the two, three dozen companies we really need to spend most of our attention?”

Some companies are early stage six people product development. In some sense they're unaffected. They're just building the product and hope to launch next year. Then there are other companies that are really affected significantly and so as a team we try to figure out how do we rally around them? How do we bring resources to bear to help them navigate through this tricky period?

Ben: As you frame that up around the portfolio companies, it sounds obvious that of course you would spend time with your portfolio companies. What are the things that you're not doing as much of that you would normally be spending your days doing? And how has this time forced you to change that?

Roelof: Seems like we're doing more of everything now. Honestly, no less of that too. Interviews are still going on. We're just doing them all as virtual interviews. I do think there are probably one or two hires somewhere where you're going to wait to meet the person in person before you make a formal final hiring decision. But for us we're onboarding people remotely.

We did this on Monday. We had a person who joined first virtual onboarding for us as our portfolio companies are doing. I was on a call earlier today with a company and they onboarded 21 people on Monday, remotely. People are going to keep hiring. They're going to keep building products. I think a lot of those things stay the same. We continue to make investments. We formally approved two new series of investments last week and those meetings were virtual meetings. The business continues.

Ben: Has something changed in what you look for in companies compared to call it two, three months ago?

Roelof: In some sense no, and certainly not at the Series A stage. I think that those companies, they're at such an early stage that product needs to be so differentiated and really solve the problem that would transcend the current market. Obviously, the US is shut down indefinitely, that's a different situation. But these companies will have a sound value proposition and once things are a little bit more normal, even if the economy goes through a recession we believe in these businesses because they're really solving really important problems. We have confidence in them.

We have asked people how they plan to respond to a change in circumstance. A little bit of a test on whether they are nimble, or they're flexible, or they just tone deaf to the reality of the world we're in right now. That clearly is a question we're asking that's different.

We're also spending time thinking about what new categories may be unfairly favored post Corona-pocalyse. Do you end up with digital health companies, online education, a bunch of things may change and are we forced into a behavior change through this environment we're in now that sticks? I think it's a really interesting question. A lot of people are thinking about this. I think it's a really interesting thing to try to conjecture.

David: That's the perfect transition to the topic we wanted to wrap up with you on. I was thinking about it when you mentioned your LP meeting next week which man, I feel for you. I know how important those are having done them, attended them, and everything.

It was interesting. Just yesterday I attended one virtually and it was amazing that it was actually better. These tend to be pretty dry affairs. This is a small example but either through the LP meeting or more broadly, have you guys started to think about what kind of permanent changes to Sequoia might come out of this?

Roelof: We really see a trend where companies are becoming more distributed partly because the cost of living in the Bay Area is so high, and the cost of hiring engineers is just so high. We've already seen a trend where companies are willing to tolerate remote work by individuals or multiple remote development offices.

I think that trend is going to gather steam. I think it’s going to run this experiment that's actually measurable on how people perform in this kind of an environment. I think that just objectively is going to change the debate because I think it's so easy.

As humans, we resist behavior change whenever we can, and this is forcing behavior change. I think tolerating businesses that are distributors, learning how to work effectively with distributed teams. I think we're likely to see people start companies in many more places, and again that's a trend that already started.

Silicon Valley doesn't have a monopoly on idea generation, and I think many more people will start companies elsewhere. We probably need to be more willing to fly, or if not fly given health issues, do online assessments of companies. I think those are clear for management.

David: You all are organized and at least have been to this point geographically. For a company, I think it can be a lot more of these like Zappier we've weighed on the show. They have no office. How are you going to think about a company like that in the future? Is that a US investment? Is that a global investor who needs them?

Roelof: Honestly, should we run into a couple of conflicts like this but I don't actually think of them as conflicts. Our team in India is an investor in a fabulous company called Freshworks.

Most of Freshworks’ customers are in the developed world including the US. My guess is the majority of the revenue comes from the US, but there is an investment out of our India office because that's where the company is based. They have a presence in the US too but we help them.

We're one partnership globally. We've done some really clever things behind the scenes to make sure that we feel like a single partnership and how we share knowledge and share compensation and things like that in a way that makes it feel good. That's a great problem to have, honestly.

Ben: There's a lot of folks talking about the sheer amount of dry powder that has been committed to venture firms in this climate. They're saying the funding won't slow down because, “Oh my gosh, there's just billions and billions and billions that's been promised to venture firms.” Therefore, deployment should continue at the exact same pace. What do you think about that? It's probably too early to tell but have you thought about whether we should slow deployment? Should we change when we want to raise certain funds? Should we change the mix of initial capital deployment versus follow ons? Does a climate affect something like that for you guys?

Roelof: The two questions there, I think the one is what’s the LP behavior, and the other one is what's our behavior? The interesting thing in 2008, not because we have a crystal ball, just because we felt things are a little frothy. Our investment pace had actually slowed down in the first half of 2008 before that happened.

Then we accelerated in 2009. If you've ever done a driving course, but I went to one in a Formula One racing track and the thing that they taught me is you break as hard as you can while the car is going straight before you get to the corner, and then you have to figure out how to accelerate at the right point at the apex out of the corner so you can sprint ahead.

This is exactly the analogy that we want to apply for our companies and for ourselves. We slowed down in 2019, not because we had some crystal ball that this was going to happen, things didn't quite feel right. If anything, I wouldn't accelerate out of this. I think it would be a fabulous investment opportunity and great companies to be built. That's what we plan to do.

For our LPS, our clients are almost exclusively these endowments foundations and nonprofits. We're really proud of the great causes represented by our LPS. We actually got an email earlier this week that about 10 of our LPS, people like the Cleveland Clinic, John Hopkins University, The Wellcome Trust Stanford, M.I.T. are all working on either better diagnostics, or potential treatments, or vaccines for Coronavirus.

We love the fact that our clients are doing these things so when we generate profits, it helps them do these things. I think our clients are relatively well protected, but if you talk about the industry at large, I suspect some LPs are going to end up with cash flow issues just like their many other businesses that are going to end up with cash flow issues that may demargin, lower the amount of venture capital being deployed over the next year or two. But that's total speculation, I don't know.

David: LPs already allocations to venture and private companies probably had already gone up so much for LPs. Just with the bull run evaluations on the private markets and lack of liquidity over the last 10 years. Now with public markets dropping so much, you can get into a situation as an LP where you aim to have 15% of your assets in private markets total and now you have 40% of your assets in private markets. That can be a scary position.

Roelof: LPs may also end up with cash flow issues on the run. A part of it we saw in 2008, 2009, where some LPS have ongoing commitments, outflow commitments. If you have an endowment to a university, you probably represent more than half of the expenditure to the university. It may be the donations dry up, or philanthropy shrinks in an environment like this, so they're even more dependent on the endowment being able to continue to pay for teachers and keeping the school hospital going. There are a bunch of cash flow issues that may also then drive people to pull back from venture capital, but it's so early to tell.

I look at the gyrations everyday in the stock market and like flip a coin, is it plus 10 or minus 10 today? It's so hard to figure out where things land.

David: As we're recording this, it's only been 20 days since you wrote the memo and again, it feels like 20 years.

Ben: Before we finish our conversation with Roelof, we'd like to thank Wilson Sonsini, the official legal sponsor of Season Six of Acquired.

Wilson Sonsini is the premier legal adviser to technology, life sciences, and growth enterprises worldwide as well as the venture firms, private equity firms, and investment banks that finance them. Thank you to Wilson Sonsini.

Roelof, I know this is Adapting and not Acquired, but we have one bonus question that we decided if we ever had you on the show after doing our deep dive on Square and doing the Square IPO. We had to ask you, what was it like navigating the challenging Square IPO and the months afterwards? Knowing what a predictable and good business it was, but just seeing what happened in the public markets after IPO?

David: This was like a key moment in Acquired history. We can look back to the Pre Square IPO Episode and the Post Square IPO Episode. It was just such a stark story to us of a company that was a great company that had just, even in the bull market run that we were in when they went public, was so misjudged.

Roelof: It was really difficult and in the run up to the IPO, because you have this quiet period we couldn't really respond. As often it happens with these IPOs is that people just keep on this negative vicious cycle of negative press. It was really painful to deal with that, and then you see the IPO price at $9. I was arguing the night before that we should price a little bit higher at least so we have more in the balance sheet. To see the way that it popped on the first day, it was still not a great outcome even at the close price on the first day.

But I felt that we left so much money on the table. The way to react in my mind was to rally the team and to talk about just we can't control our stock price, but what we can control is our execution. I think the management team did an incredible job of saying, “Look, it is what it is. We got through it. Let's hunker down and let's just build a great business,” and they did that.

Then what we did as an investor is we were patient. We didn't distribute a single square share until four years after the IPO, four years. That meant that we distributed and we still haven't fully distributed by the way, because I have so much faith in this company.

David: You're still on the board, correct?

Roelof: I'm still on the board. I love working with the team. I love working with Jack. I love the mission of the company around financial empowerment and the fact that we're able to do that now not only for small businesses, but also for consumers with this great cash up.

I think it's a fabulous company to be associated with from a mission point of view and actual financial results. My partners and myself, we were just really patient. The fact that it was nine dollars a share IPO didn't matter because we distributed shares when it got to 80. At the end of the day, we made a much better return for our limited partners by being patient. I think the team also appreciated us as a really patient investor.

Ben: It's great.

David: Thank you for sharing. That's a good note to end on with this moment in time like for great companies, they're going to survive. They're going to hunker down and now is not the time to liquidate your shares.

Roelof: Yeah, I think it's, focus on the long term. Solve real problems.

Ben: On that note, Roelof, where can our listeners get in touch with you? With Sequoia? What's the best way?

Roelof: My first name roelof@sequoiacap.com

Ben: Great, are you on Twitter?

Roelof: Yes, @roelofbotha. Signed up in 2007.

Ben: Nice.

Roelof: I've been a user for a long, long time.

Ben: That's awesome. Thank you for joining us. Listeners, we hope you enjoyed this episode of Adapting. Please send us feedback at acquiredfm@gmail.com or join our Slack, and we’d love to talk to you there. Roelof, thanks again.

Ben: Thank you, Ben. Thank you, David.

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