We cover Sequoia Capital a lot on this show. Not only across our now four (!) dedicated episodes, but across a stunning nearly 50% of recent season companies where Sequoia was a primary or only investor — the most of any venture firm by an enormous margin. Today in this very special episode, we dive into the principles that have led to the firm's 49 years of unparalleled success in venture, and the playbook behind how they identify markets and companies that create outcomes worthy of the firm's namesake tree.
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1. Bring a prepared mind.
2. The two questions that matter are "Why now?" and "Who cares?".
3. The goal is not buying low and selling high. The goal is compounding capital.
4. Venture is a humbling business.
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!
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…
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!
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.”
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.
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.
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.
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.
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.
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...
Purchase Price: $1 billion, 2012
Estimated Current Contribution to Market Cap: $153 billion
Absolute Dollar Return: $152 billion
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.
Methodology and Notes:
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Transcript: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)
Ben: Welcome to this special episode of Acquired, the podcast about great technology companies, and the stories and playbooks behind them. I’m Ben Gilbert and I’m the co-founder of Pioneer Square Labs, a startup studio and venture capital firm in Seattle.
David: I’m David Rosenthal and I’m an angel investor based in San Francisco.
Ben: And we are your hosts. Sequoia Capital needs almost no introduction. When we did the comprehensive two-part series on their history, we noted that they had invested early in companies that went on to be worth over $3.3 trillion. At the time, the market cap of the entire Nasdaq was about $10 trillion. I’m sure both of these numbers are dramatically higher right now as we record this in January of 2021.
At the end of last year, we saw a Sequoia doubleheader in the two enormous IPOs of DoorDash and Airbnb. Alfred Lin (a partner at Sequoia) sits on not one but both of these boards. As pointed out by Dan Primack at Axios, these were his first two IPOs after his decade at Sequoia. It certainly pays to be patient.
After that, we couldn’t help ourselves but reach out to Alfred to have him back on Acquired and ask the questions. How does Sequoia identify these investment opportunities? What is the internal playbook for creating their famous prepared mind to evaluate such opportunities when they come along? Today, we dive into what this all means in practice at Sequoia and we take a few lessons from what they’ve learned in over 49 years of finding and building great companies.
David, who is Alfred?
David: Forty-nine years. That’s incredible. Alfred, as we covered with you on our Zappos episode, is the CFO of LinkExchange and Tellme Networks, the co-founder of Venture Frogs with Tony Hsieh, and the COO and chairman of Zappos until its sale to Amazon. Today, after his partner at Sequoia where he manages the early-stage business in the US and sits on the boards of Airbnb, DoorDash, [00:02:31], Houzz, Instacart, Reddit, Zipline, and more.
Alfred, I know you’re going to shrug this off and use the Robert Louis Stevenson quote that you love about judging each day by the seeds you plant, not the harvest you reap, but we have to congratulate you on those two IPOs—DoorDash and Airbnb—last month. Truly amazing.
Alfred: Thank you, and thank you for having me on the show. I would point out that this is a team effort. Many of the companies that we work with—I may represent Sequoia on the board—is the whole partnership that brings the weight of Sequoia to the table and helps those companies become legendary companies. We couldn’t have done that without the spectacular founders that we partner with. The kudos goes to them for having the courage to start those companies and wanting to put a ding in the universe.
Ben: Love it. That is everything that we’re going to talk about here today.
Before we dive in, we have a very special presenting sponsor on this episode. The Massachusetts Institute of Technology Investment Management Company or MITIMCo. MITIMCo is on a mission to deliver outstanding long-term investment returns for MIT. They are sponsoring the show because they themselves are listeners and know that some of the very best thinkers, leaders, and investors in the tech ecosystem are listening. MITIMCo is always looking for the best talent in the world, and they have a track record of partnering very early on.
I’m here today with Nate Chesley, a global investor at MITIMCo. Nate, it’s a pleasure to introduce you on Acquired. My first question: Could you expand on MITIMCo’s approach to partnering with investors?
Nate: Ben, it’s a great pleasure to speak with you. We partner with leading investors who have built competitive advantages with attractive opportunity sets across the globe. This ranges from early-stage investors to stock pickers in the public markets, to operationally-focused specialists in areas like real estate and private equity. Of course, we’re looking for the combination of both exceptional investment talent and the uncompromising integrity required to be stewards of MIT’s resources.
Ben: That’s great. I know you’ve been an early investor in some of the most enduring investment institutions in the world. How do you identify them, and how do you balance being early and experimental with the risks that come with that approach?
Nate: That’s a great question. Having one customer—MIT—with a very long-term time horizon is perhaps our greatest advantage. We’ve learned over time that by partnering with investors early on, we increase our odds of having multi-decade relationships, and with that, the potential to create tremendous value over time.
Being early requires us to think outside of institutional norms. A lot of investors start their journeys with a narrow view of what it takes to succeed. Our experience is that ignoring conventional wisdom, investing from first principles, and operating lean are all common ingredients for success, irrespective of conventional measures like pedigree, a large starting AUM, or a long track record. We take the view that no firm is too small, too early, or too uninstitutional to reach out to us.
Ben: Love that mindset. Thank you, Nate, and thanks so much to MITIMCo. They are truly some of the best and most well-known investors in the LP community. Their investment performance supports MIT’s cutting edge research and world-class education, which has produced alumni who have gone on to build enduring companies like Stripe, Dropbox, Khan Academy, Qualcomm, Akamai, TSMC, VMware, even Fairchild Semiconductor, and countless others. If you or someone you know is starting a fund or recently launched, you can click the link in the show notes to learn more, email firstname.lastname@example.org, and just tell them you heard about them on Acquired.
David, take us in.
David: Alfred, to kick things off, can you give us a little bit of the history of how this idea at Sequoia of wanting to have a prepared mind going into markets and investments and meeting teams came to be?
Alfred: I think it all started with Don thinking about the market. The thing that we look for is a combination of a great founding team and a great market. Great founding teams find great markets, or they find a wedge into that market, or they find what’s wrong with the market, then they discover that there’s a problem that the world has gotten wrong, and they want to fix that problem.
We’ve always had to listen to founders because they come from the problem of solving their own pain. They may not be thinking about the market per se; they’re thinking about the problem that they have. To pair up, work with, and partner with these great founders, we have to come prepared thinking about the market and thinking about what the market can become.
Nobody’s going to wake up one day and suddenly know, oh yeah. Lots of people are going to share their bedrooms or couches with a total stranger. Nobody’s going to think that if you don’t have density in the suburbs, that you can actually make a delivery service work. You do have to think about this from a perspective of having been prepared, and thinking about both the market and the ability of the market to grow and change.
We often talk a lot about the prepared mind because “Chance favors the prepared mind,” as Louis Pasteur would say. When Jim Goetz joined Sequoia, he had identified a lot of interesting areas to invest in. He pioneered some of our thinking of having landscapes and having a prepared mind for the mobile landscape, for the rise of the developer. He would work and try to understand the landscape of what it was possible—where were the white spaces, where were the places that you can actually build a company—because the incumbents, the legendary companies of the past were not so much focused on those areas.
If you wanted to think about Airbnb’s case, Greg [00:08:39] have been thinking about timeshares and vacation rentals for a long time, because it was weird that hotels were slowly being aggregated onto global online travel platforms. That wasn’t quite true what timeshares and vacation rentals to the same extent. It didn’t lead necessarily immediately to an investment, but it gave us a prepared mind on localized listings didn’t really exist, VRBOs and HomeAway made most of its revenue from advertising rather than booking and the transaction itself. When we saw Airbnb, it’s a completely different vector and a different way of thinking about the business.
In DoorDash’s case—since you asked about DoorDash—between 2011 and 2013 with the rise of the on-demand economy, we actually evaluated a variety of investment opportunities in the space. We met with Grubhub, we met with Caviar, we met with PostMates. Each time, we pass. Not because we are uncertain about the market size. We actually noticed that this required a very, very operational founder. This business is going to be won by both having a differentiated strategy but also a person and a team that was going to be very, very focused on operations.
When we met Tony that was a combination we saw. He had a differentiated approach. The differentiation for him was the strategy of focusing on the merchants and in the suburbs. The thing that he also brought was his keen eye for operations. Unfortunately, we decided to pass on the seed. That’s my fault. It took time for us to understand that Tony was a different character. He had both the strategy side as well as the operational side that brought what we consider founder market fit. We invest in their series A and in every single round after that.
Ben: And as you think about the way that you had previously thought about this food delivery market, the way that Greg had been thinking about the timeshare market and all that was wrong in aggregating it, how does something bubble up within Sequoia from someone’s personal fascination with something to doing proactive work, to come with a prepared mind when you do start to see pitches?
Alfred: The simple answer is there’s no straight formula for any of this. The way that it has bubbled up has come through because we need to identify a trend through just reading. We’re curious about vacation rentals. We start reading about it. We start digging into it. Nothing may come out of it for that particular point in time, then later on it becomes more important. It can be a full-blown landscape that you plot out and write up a memo about exactly what’s going on in the landscape—who are the players, what’s going on, where do we see white space. It could be anywhere in between. Mention it to your partner. What do you think about this idea? What do you think about that idea?
We have blue skies sessions every quarter where we just try to dream. This business is about inspiration just as much as about perspiration. We need to both hustle but at the same time, we need to be able to think and be inspired about the world. Some of it comes from reading and some of it comes from just talking to founders.
Other landscapes have started because we met an interesting founder with an interesting idea. They’re actually still roughing on the idea with us. We go deep with them, as well as go deep with other founders who are in that space trying to make sense of what’s going on. The ways that this has come about has come from complete randomness and serendipity, to very, very structured thinking.
The great part about Sequoia is we have a partnership. We have people who love to be proactive and think structurally, and we have partners who love to be in the ecosystems, meeting lots of people, and riffing ideas with lots of people in an imaginary way and dream up ideas with others. This is a business that you can do well with both someone who’s an introvert, as well as someone who’s an extrovert.
David: When you get to the landscape stage, whether you’re looking at a space as part of a team at the firm, or maybe you’re looking at a specific investment and you’re doing due diligence on that investment, what are the key things you’re trying to understand? Don and some of the old... like to talk at GSP, oral history with him. He talks about needing to understand what the change is that’s occurring in the market, needing to have a very specific problem that the company is solving, needing the timing to be right. What are these key features that you guys are focused on?
Alfred: The simple questions are you’ve heard before, that is why now? What many of these ideas have people thought of in the past? It’s not the first time that someone has decided that we should deliver food there. In 1999, there was a company called Cosmo that opened up in New York. That didn’t work. Why is Instacart in a much better position today than they were when Webvan started and Webvan didn’t work?
I think there are specific good reasons for ‘why now’ and there are times when there’s not a good ‘why now.’ In Instacart’s or Doordash’s case, the ‘why now’ has a lot to do with mobile and the on-demand economy. People have always wanted instant gratification, but the ability to get an on-demand workforce was not available in 1999 because not everybody was carrying a mobile phone. There are certain situations where you have good ‘why nows’ for a particular company to be able to take off.
The other question we ask all the time is, in 10 years who cares about this company? Tony used to ask who cares. It applies to who cares today but it also because we’re investing early and we partner early. We partner at the idea stage, at the seed stage, and the venture stage, at the series A. The company has to be an important company 10 years from now, so who cares 10 years from now? What does this company become in 10 years and now?
Imagination about that and what happens when everything goes right is really important. We do ask, if everything goes right what does this company become? In the early stages, it’s easy to spot why the company may fail, but it isn’t quite easy to write the premortem of a company. What will go wrong? What are the major risks? It’s sometimes very hard to really write about what this company can become.
Ben: Do you find that founders know this at the seed stage? David and I know this from meeting with very early-stage founders, that so much is going to change in the dynamic market over the next 10 years. Do great founders know what the right picture looks like? Is the Brian Chesky of today able to fully articulate that they’ll overtake hotels?
Alfred: I think it’s easy to look back from now when it was obvious. At the time it was not always obvious. What they will articulate is that people should do this, this way. The way I view the future is a far superior future. That’s the dream that you have to be able to riff on and if that’s the future, can you build a really large company?
In some cases it’s more obvious because the market is so large. If you get just even a slice of the market, you’ll be in a good position. In other cases, it’s less easy because you actually have to dream that the market gets bigger, that you’re going to change behavior, you’re going to take away from a different way that people used to do something. Both can happen, and we generally like the more non-obvious markets where they’re good tailwinds, the markets could be small at the beginning, and it can grow over time.
Everybody knows where all the large markets are, and it’s generally a bloodbath when you enter those markets. I’m not saying that competition is not going to happen. In every company, if you’re afraid of competition you should just get out because if you’re at all successful, someone’s going to come after you.
For a startup, you want some air cover at the beginning. You don’t want to go into a competitive market and go head-on with a large competitor on day one because they’ll just crush you. You need areas of white space. You need a market entry strategy where people think, that’s a little company. That’s kind of cute. Go ahead, you can take that.
In Innovator’s Dilemma, they talk about all the low margin stuff. The big companies always give the low margin stuff to the startups because the startup sees it, who cares, not a lot of margin in that. They get really, really good at that because they figured out how to make money with low margin, they go up market to the higher margin stuff, and then eventually they overtake the industry.
That is one way (obviously) of entering the market. There are other ways of entering the market just with a superior product, so you get more and more people to talk about you. If it’s 10 or 20 times a better product, everybody’s going to talk about you and will migrate to you. There are other ways by having a completely different strategy if everybody thinks this is the future, and maybe someone else’s buck. Not everybody is the same. You’re not going to capture 100% of the market in something as big as travel. It’s the ability to differentiate yourself from a current trend (sometimes) that makes you successful. In both Airbnb’s and DoorDash’s cases, that is exactly what happened.
David: I’m super curious and I’m sure everybody listening is too right now. When you’re debating that question within Sequoia, like is Brian right? Is this going to move beyond air beds? When the conventional wisdom is ‘this is cute’ and you’re debating ‘is this going to be more than cute,’ what does that look like inside the firm?
Alfred: It has a lot to do with the sponsor. In Airbnb’s case is Greg, and in DoorDash’s case, me painting a picture of the world, and showing the conviction of why you believe that this is going to be the case. It happens over and over again. You might be an investor in the seed like we were an Airbnb, and in the A you still have to paint the picture again and maybe is it bigger?
Sometimes, it’s easy to dream with these companies because every single point along the way, they’ve outstripped everybody’s expectations. It’s not just because there’s more usage or more revenue, but the way the world has reacted to the company is just phenomenal. Doug Leone used to always say don't fight the tape, and sometimes the evidence is just in the tape where they just keep growing, they keep doing well, they attract great talent, people love the service, and they continue to broaden their vision.
Every single one of these companies had challenges. Airbnb had a PR crisis with EJ. They also had a crisis where people were fighting tooth and nail with them, and copying every pixel of their website in Europe. They decided that they wanted to win Europe. They were either going to potentially buy Wimdu or merge with them, or have to go down the path of a pretty expensive ground war. They decided to do that and won. Some of these things have to do with just being crafty and being smart about exactly how you go about winning and coming out on top.
Ben: I'm curious to dive in on that a little bit. So they decided to do the very expensive ground war with Wimdu and part of that financing came from you. How did you think about evaluating whether that was a good use of capital versus any other place that you could place that marginal dollar as Sequoia?
Alfred: It's always easy to say in retrospect that it was obvious and everybody talks about that, but what's obvious at the time is that travel is a global network effects business. Maybe not today during the pandemic—it's more localized—but we're going to get past the pandemic. We’re all going to get vaccinated. People will go back to traveling. Traveling won't be the same as before but we all love visiting different parts of the world. What is true is that you want to travel to different parts of the world more than you do locally. If you win that, if you win the supply you will most likely get all the demand. That was the reason why we had conviction on investing more in later rounds.
David: Make sense. I'm curious in that specific case with Airbnb. We covered it so many times on this show—Airbnb episode and many others—that global network effect is so powerful. One of the reasons why Airbnb has been able to build so much power in the Hamilton Helmer sense over the years. When did you guys realize that at Sequoia? Was that part of the thesis going in? If this works, if we can build up supply and demand globally, there is an opportunity for a global network effect here. Or is that something that revealed itself over time as you were saying?
Alfred: I think part of training is that you can create one. It's not that it got realized on our seed investment. At the seed investment, they had a listing service. They had 2000 or so listings. They had a few transactions. It was definitely not a network effects business at that time, but you have to dream that if you get enough of the supply it should be a network effects business. That's part of having a prepared mind.
The concept of a marketplace has been around for awhile, pioneered by eBay on the internet, but it wasn't the only marketplace. We've had other marketplaces and a stock exchange is a marketplace. Having a prepared mind allows you to think about these conceptually into the future, even though it may not ring true the day you make the investment.
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I want to switch gears a little bit here and talk about market size, which, for any early-stage entrepreneurs listening who are currently in a small market but are dreaming (as the way you put it out for it could be a big market), encountered the experience of banging their head against a wall because entrepreneurs keep getting these past emails from venture capitalists that say, market’s too small. How do you think about, as a great investor, whether the market is small today and will stay small, or whether the market 5–10 years from now could be enormous? How do you work that into your investment decision?
Alfred: That's a great question. I think the reason why there's a lot of passes on market sizes, Warren Buffett famously said, “When a management team with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.” It is good advice. It's not advice I often talk about with founders because the one thing that is a little different at the early stages is that you're going after non-obvious-markets. If you go after obvious-market as we talked about—it's a very large market—there is intense competition because it's obvious. If you go after a small market and it's obviously a small market, that's also a bad idea.
The question is, are you actually in a small market that looks small today but it's actually going to be a big market in the future? That's how I would like to have that conversation with the founder. Why is this market going to be large in the future?
There's a bit of the founder doing some work, there's a bit of the investor doing some work, and we certainly do our own work at Sequoia. Then, we work with the founders so they’ll think about it. Some of it has to do with what are the trends that are carrying you in this business?
It's not hard to know that mobile is going to be a big trend back when mobile was a big thing, but mobile had some fits and starts as well. We thought we could build mobile just on a StarTAC phone, but the user experience wasn't great. Mobile really started to take off because the smartphone started to take off and it was a fully-functioning computer. That was what carried mobile through over many years.
The move to SaaS was actually identified way before this current wave because as soon as you saw people moving racks into colocation spaces, you could see that more and more software is going to be written and put in the cloud. It tool AWS coming around where developers are starting to bill for the first time right straight into someone else's racks, not your own, that you're like, okay, well this is going to carry for a long period of time because it lowered the cost of starting a company.
A developer, Jim Goetz, who talked about having a prepared mind, talked about the rise of the developer as a landscape because developers didn't have to rack their own racks anymore. They didn't have to go raise a bunch of money to buy the servers and put it in their own CoLo. What they needed was just be able to have a credit card, start coding, and put it on AWS. You could see that was going to be a trend for some period of time.
David: There's that amazing moment that we talked about in the Airbnb episode where the YC startup school where Bezos launched AWS to startups, was the startup school that Brian, Nate, and Joe went and attended before they did YC.
Alfred: Yeah. Again, these little things happened and you realize it's going to unlock an explosion because otherwise, Brian, Joe, and Nate would have had to rack their own servers. For them that's no fun because they’re two designers and someone who wrote code. I don't think Brian or Joe, maybe Nate would be okay with going into CoLo and racking racks, but I don't think Brian or Joe are pretty particularly happy doing that.
David: But the company might have been DOA if they had to do that.
Alfred: Exactly. Those trends that carry you are quite important. I often talk about there are three components of a pitch. Some founders do all three well and most founders do the first one well which is what's your vision of the world? In the beginning, you paint this picture of what you want the world to become. You've experienced personal pain that this is not the right way to do this. You show how passionate you are. You have a vision of the future of how the world is going to be different.
Then, you have the realities of today. Paint the pictures of what's going on, why this is broken, how you can fix it, how many customers you think you can get because they face the same pain that you do. And then, to connect the dots between those two worlds.
You won't have to paint the whole picture, the whole path of how you get from where you are today, and into the future, but you do have to show us how exactly you’re going to get from a few thousand listings at Airbnb to more than that? You do have to start talking about, okay, well, if you're not going to focus on the cities where all the volume is and all the density is, how do you win in the suburbs? If you want us to believe in the suburb strategy, how do you win the suburbs?
In both cases, they had very good answers to these questions. The notion was, it didn't work outside of New York City because the only reason it worked in New York City was because of the density. That was a false assumption. It was not backed up with fact. Tony was very good at pushing on that. He’s like, does it only really work in New York City or does it work on elsewhere? How can it work elsewhere?
Ben: It was funny we've danced from this idea, this question around market size to this topic in unit economics of will it work in a given market? Don, among only a few other factors early Sequoia days, would say that the very important things in evaluating opportunity are the market size because no one ever started a huge business in a small market, and the potential for large gross margins. I'm curious. As you come with this proactive stance and a prepared mind when you're meeting with entrepreneurs, how do you apply that thinking in unit economics? Is it still important today to be able to start a business with high gross marginability in your eyes.
Alfred: The answer is nuance. High gross margin, as Bezos would say, is not about margin percent, it's about margin dollars. If you have large margin dollars, that can be okay even though the gross margin percent is not as high. If you're going after a low gross margin percent business, you just need a ton of volume. You need high repeatability.
That notion of gross margin is a strange thing. If you'd look at DoorDash from a GMV standpoint, then their gross margin is really low. But if you just look at their take, if you net out everything else, then their margins are decent. The same is true with Airbnb. People don't think about this, but nobody measures Airbnb’s margins off of their GMV. They measure it off of their take rate. Some of this stuff is a little more nuanced than that. Software businesses, you're paying for just the software. You're not looking at all the search transactions that happen on the software.
The reason why unit economics is important is because eventually, this has to be a business. To be able to be valued highly, eventually you'll be valued off of your profits and a multiple off of your profits. The confusion is the availability of capital. In the last few years a lot of people have complained there's too much capital in the system. There's always been too much capital in the system. When I started 10 years ago, I was frustrated. There was too much capital in the system.
I remember sitting, my desk was right next to Mike Moritz and I said, hey, there's just too much money in the venture ecosystem. He’s like, yeah, thanks for observing that. Go back to work, and your job is to figure that out. I was like, that's not a satisfying answer, and he’s like, well, there's too much capital in the system. I agree with you. Well, you know what? Ten years before you there was too much capital, and 22 years before you when I started in the venture business there was too much money in the system. There’ll always be too much money in the system.
The thing that we've learned over time is that the winners get a disproportionate amount of the market cap. If that's true, then by just simple logic investors want to invest in the winners, so the winners get more and more of the capital. If there's more money in the system today, the winners will get more money. That allows them to do things slightly differently.
I used the case where in ecommerce when I was at Zappos, we needed to make sure that the payback on the CAC was on the first order. I don't think any company today in ecommerce does that if you have more capital. If you know it works on the first order and if I give you a little bit more capital, maybe you can extend it to seven days, or a month, or six months, or a year.
I do think that this transitive property doesn't always work. If it works with zero cap, you can do it for a year, two years, three years, four years. At some point it breaks because at some point you won't be able to raise enough capital to keep you afloat. But I do think there is more willingness to see unit economics payback over a longer period of time if the market is large.
David: That makes total sense. Unlike the early days of Sequoia, you have different entry points where you can partner with companies now, whether it's teaming with the entrepreneur at the seed stage or partnering at the growth stage with more established companies that have already answered some of these questions. As you're thinking about a given market, how do you decide—whether that winner that you mentioned that's going to get the lion share of the market cap in the space—if it already exists and you should go invest at the growth stage, or there's still an opportunity for a new entrant at the seed stage?
Alfred: I think the simple answer is that we at Sequoia want to identify the most important companies of tomorrow as early as possible. We do want to partner with them at the seed stage and be there for them from idea to IPO and beyond. I would point out that there's so much going on in the world. There's so much innovation that we're not going to get to every great company at the seed stage. They're going to be companies that we miss at the C that we'll do at the A. There companies that we miss at the A that hopefully we do at the B. And companies that we miss at the B that hopefully we pick up at a growth round.
In some sense we can enter at many different levels, but also, what's an interesting company at the seed is going to look very different than a company at the A or the company at the growth round? Just a simple idea, like what's happening at the C identifying new markets? You have this view that the market will be very, very different a few years from now is different than a growth round. You may be looking for a developing market that continues to grow, but it is somewhat established, if not already developed when you make an investment at the growth round.
David: That makes total sense. That also brings up a question I've been dying to ask you guys. The other dimension that's changed over the years at Sequoia is not just the stage at which you invest but geography too. Obviously, you have a very robust practice in China, India, and now you're building one in Europe, everywhere around the globe. How do insights and learnings from each of those geographies influence your thinking back here in the US and each other?
Alfred: The fact of the matter is you can start a company almost anywhere in the world. “Talent is evenly distributed and opportunity is not,” is a quote that lots of people have said. We're expanding around the world because we want to be a global partnership, and we do learn from each other. Their observations around the world are that people are pretty similar. They do things slightly differently because of cultural reasons or how they grow up.
We want similar things. From a consumer standpoint, if something works in one geo it's likely to work, maybe not the same exact formation, but it's likely to work somewhere else and vice versa. If you come up with a great, interesting, efficient way of doing things on the enterprise side, it's probably going to be wanted in different parts of the region.
Just as an example with DoorDash where investors in Meituan in China. There are a lot of learnings back and forth about what works, what doesn't, how much market share you need to get, how much your unit economics changes when you get to scale, et cetera. The growth path of this viability of the business can be learned across the world.
The other thing related to the pandemic—I think there was a lot of learning—China faced this virus first. Tony called up people around the world that we're facing the same issues. Tony realized the most important thing was to keep the restaurants open. There are parts of the world where the restaurants are closed. So long as you keep the restaurant open, and then you can fix some of the other issues. They onboarded restaurants as much as they could. Once you did that then you needed to solve the issue related to drivers. Provide them with masks, PPE, and also work on contactless deliveries. If you did that, and you got the food safely to the customer, the customer obviously wanted to order.
Ben: I'm curious, you brought up this idea that we keep in touch and we learn from each other around the world. As Sequoia grew from a few partners to several pieces of a larger partnership and these global offices, obviously you increase the overhead. You could spend all your time communicating with each other. It's a large organization with communication networks like any other. How do you find that fine line? I'm curious if you have a meeting cadence or anything like that, where you do get to learn from each other, but you're not spending all your time communicating with each other.
Alfred: It's very lightweight. Sequoia is structured in a very decentralized way. Each group makes their own investment decisions. Each geo makes their own investment decisions. We do that on purpose because what's on the ground is way more important than the global themes and the global trends. You can think about the global themes and the global trends on a quarterly basis, but you're acting locally every single day. So we try to think globally but act locally. That's the mantra that we have inside of Sequoia.
David: What did the different operating teams look like, just so people get a sense of scale? They’re not very large, right? How big is the US early stage practice?
Alfred: The early stage team is about 15 people. It’s not a big team. The way we think about it is while there’s a lot of opportunity, each one of us is only going to make one or two seed investments or one or two venture events a year. The reason we keep it small is because what we enjoy is to partner with the founders as early as possible and help them and their companies reach their full potential.
That is an enormous amount of work and we enjoy that part just as much as meeting new founders and thinking about the future. But once we make an investment, we want to bring the future to fruition. It’s not just about making the investment. We don’t really think about buying low and selling high. We think about helping founders reach their full potential. Bring the future that they envision to reality.
David: The next thing I wanted to ask, in many ways, Sequoia’s history that has sparked me thinking a lot about this over the past year and the Apple investment that we covered so many times. That was an early example of buying low and selling high that, in the long run, probably served Sequoia. Not nearly as well as it could’ve. I think you guys made $6 million in net profit on the early pre-IPO Apple investment.
How do you guys think about time horizon? Obviously, you need a long time horizon as we’re talking about that’s the way to compound capital. At the same time, you are a fund structure, a series of funds. You have limited partners, they want distributions at some point. When do you guys think about the right time to start to distribute out your investments?
Alfred: We think about whether the company has brighter prospects in the future than they do today. If that’s the case, then we continue to hold. We don’t actively think about distributions from an IRR money-on-money perspective. Yes, obviously, we are a fund and we get measured that way. But we’re very proud of the fact that our as held multiples are higher than our net multiples of the stock we distributed. It’s a deliberate strategy that that’s the case.
The reason that that is is because we both pick the right founders who want to build long-lasting companies and we help them focus on what’s enduring about their business. You’re just a lot better off focusing on the long run than any short run swings up or down in the market.
When we distribute, yes, it’s because it’s maybe the end of the life of the fund, but it’s more about even when we distribute we hope that the company has much longer prospects than the day we send the shares to our LPs. We distribute shares and let our LPs decide whether they want to sell or not. We generally don’t sell the stock.
Ben: It’s funny. It’s a nice thing to say we’re long-run–focused over short-term–focused. But in the business that we’re in, it’s quite literally and mathematically just a much, much better strategy given how much of the area under the curve of a compounding returns business shows up in those later years. I think I heard a stat recently that Amazon made as or more money in its 21st year after IPO than the entirety of the 20 since IPO. It’s just funny to think about these businesses that we’re in. The opportunity to invest where you’re investing does come early, but the real returns do come much, much, much later.
Alfred: It’s a testament to compounding, the thing that people don’t get right and it’s hard for us to understand compounding because we’re human and we like linear projections as opposed to exponential projections.
David: We get it wrong in the beginning and in the end.
Alfred: Yeah. The things you get wrong at the beginning is it looks linear, it doesn’t look like it’s compounding. Actually, early years of compounding look very linear. In fact, at any point, compounding still looks linear exactly where you are. The tangent of it looks very linear and it’s not that far off from being linear or you draw the line wrong. It’s almost always more obvious after the fact that you’re in a compounding situation.
I hope that people understand that more given what’s happening with the pandemic because that is also an exponential growth to the situation. We always get surprised and then we clamp down after the fact and we still continue to see cases after people take more precautions over a longer period of time because compounding is a hard thing to reverse.
Ben: That’s such a good point. All right, for our final sponsor, we’d like to thank Perkins Coie, the official legal sponsor of these special episodes of Acquired. As long-time listeners know, Perkins Coie is a premier technology focused international law firm known for providing high-value strategic solutions and extraordinary client service to businesses ranging in size from startups to the Fortune 50.
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I have one more structural question here before we start to wind toward the end of our episode. A lot of people who are building firms or building enduring institutions of any type, look to Sequoia as an example of 49 years high performance at almost, if not every stage along the journey, building from a small group of people into a globally distributed team that runs like a well-oiled machine. At least, perception from the outside.
I’m curious. What are some of the practices that have contributed to allowing you to learn, get better, and become that enduring institution, instead of something that flames out at some point? I’m thinking, do you do post mortem? What do you think about learning from your mistakes, learning from your successes? How does that all happen?
Alfred: This is going to sound trite, but it had to with Don starting out and calling at Sequoia Capital instead of Valentine Capital. He had set the culture right at the beginning. This is a people business, we hire partners that Don interface with our founders. There’s very little secret sauce in this business, and the simple fact of basically calling Sequoia Capital because he wanted to build the tallest tree inside of venture capital makes a statement.
It also makes a statement that the firm is not his, that he’s around to start the firm and then he’s going to hand it over to Mike and Doug. It’s their job to keep Sequoia going, and at some point they’re going to go, they’re going to hand it off to the next generation and the next generation after that.
Ben: And you’re pointing out that he didn’t put some high value on the management company because it had been so successful to sell to the next generation, he literally just said, you own the management company, right?
Alfred: Yeah. Nobody owns the management company at Sequoia. The GPs manage the management company. We don’t view it as owning it, we view it as we inherited it from the last generation and it’s our job to make sure that we pass it on to the next generation in better hands. All of us come to Sequoia, being able to stand on the shoulder of giants and we want to make sure that this place is better off for the next generation.
Just coming off of that is a huge base to be able to build upon. In terms of constant learning, this business, you need three key ingredients. I think I’ve said this before, which is you need high IQ, high EQ, and high hustle. And then you need to apply it appropriately. If you’re just super smart but you can’t influence your founders or have them influence their management team to do the right things, that’s not really going to work. Just because you can identify something wrong with the company, this is a business of influence. You got to influence people that take your money because it’s your money as just as green as everybody else’s.
More importantly, after you make the investments, and you become partners with the founders, you have to influence them to do a bunch of things that they may not like. Most founders have strengths, then have weaknesses. They’re really good at certain areas and you have to influence them to round out and build a company not just a product or a feature.
This business is high hustle. You hustle every single day going after a theme or a trend. How do I think about that and turn it into understanding the whole landscape of what’s going on and then picking the right founder to partner with, to build a company in that space. Those things require an enormous amount of effort and time. It requires being both a skeptic about what’s going to go wrong and also requires a lot of imagination for what can go right.
Back to there’s no secret sauce, if you want to be good at this business, you have to be a constant learning machine. You got to think about every single day what you can improve for the next day. In terms of compounding, that’s probably the most important thing. If you can just improve a little bit every single day, you want to suck lust tomorrow is one way to think about it.
This is a humbling business. When I joined, I remember Mike saying a line which was jarring. That this is a humbling business because you can make money even if you got the investment thesis wrong and you can lose money even though you got the investment thesis right. If you don’t get cognitive dissonance hearing that, you have to be both excited by that and also know that you’re not going to get things right every single day.
This is what people who are in this business for a long time continue to love. There is an element of meeting founders that even if you don’t agree with them, it’s infectious to hear them speak because they’re painting a future of the world that’s just different. Then, there is the element of gosh, I got that wrong. Gosh, I got this wrong. Gosh, I made money on this, but I still got most everything wrong. Was I just actually good or was I just lucky?
I always tell people if they want to join venture capital, they’re like, I’m going to try to convince you not to join and then after all of the reasons why you shouldn’t join, you still want to join, I’ll tell you more about it. It will take a decade or longer for you to figure out whether you’re good at this business or not. Maybe you’ll find out you’re bad at it because you can’t get in front of interesting opportunities, you don’t dream enough. You can find that out relatively quickly, but you won’t know that you’re good at this for a long time.
David: You’re now in a position where you’re doing a lot of hiring (I assume) at Sequoia in a way that Don famously did in DSPV. From the top lecture, he held up your resume the day you joined Sequoia. When you’re evaluating people to join the firm, what qualities do you look for that give you an inkling that they might be good at this?
Alfred: High IQ, high EQ, and high hustle.
Ben: David, weren’t you listening at all?
David: Obviously not.
Alfred: There are no real requirements for this job. You can put anybody’s resume up and they can become a great venture capitalist. There’s an element of those raw ingredients and then there’s an element of desire. It pays you to be in it for the long run. You’re not going to get your biggest gains on day one. You’re going to see all your losses earlier in your career and your gains take a long time to develop. Maybe the other element is just to focus on the enduring, which is one of our tenets.
Ben: Alfred, I can’t think of a better place than that to leave it. I do want to give you the floor and say if founders are thinking about reaching out to you, who should reach out and how can they get in touch?
Alfred: Just simply email me. I’m email@example.com if they want to reach out to me. Another word of encouragement for founders. You’re doing good work and keep it at, keep thinking about every single day about how you can build a sustainable business because your business model and your business plan is the strategic weapon. We provide capital which is fuel, but you need a strategic business plan first before you can do anything with that fuel.
Ben: I love it. Alfred, thank you so much for joining us.
Alfred: All right, thank you.
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