Sequoia’s Roelof Botha: Why Venture Capital is Broken & How Great Companies Are Built
In this episode of All-In, Sequoia Capital's Roelof Botha shares insights into venture capital's current challenges and transformations. He discusses how the industry faces difficulties due to excessive investment, requiring over $1 trillion in annual exits to maintain returns, and explains Sequoia's Scouts Program, which has achieved a 26x multiple on investments by enabling talented founders to invest in promising startups.
Botha outlines Sequoia's approach to investment management and organizational structure, including their strategy of retaining shares in successful companies post-IPO. He also addresses the firm's international investment experience, particularly in China, where regulatory uncertainty has significantly impacted new company formations. The discussion covers how Sequoia balances individual initiative with collective decision-making while maintaining its status as a private partnership focused on long-term stability.
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1-Page Summary
The Sequoia Scouts Program and Its Impact
Sequoia Capital's Scouts Program, launched in 2010, revolutionized venture capital by enabling talented founders without personal wealth to invest in promising startups. According to Roelof Botha of Sequoia Capital, the program has achieved remarkable success with a 26x multiple on investments, leading to significant investments in companies like Uber and Stripe through scouts such as Jason Calacanis and Sam Altman.
Current State and Challenges of Venture Capital Industry
The venture capital industry currently faces significant challenges due to excessive investment. With annual investments between $150-200 billion, Botha explains that the industry would need to generate over $1 trillion in annual exits to maintain reasonable returns. This creates what he calls "return-free risk," as the abundance of capital doesn't correlate with an increase in quality investment opportunities.
Sequoia's Culture, Leadership, and Investment Approach
Under the leadership of Doug Leone and Michael Moritz, Sequoia has developed a unique culture balancing individual initiative with collective decision-making. Botha describes how the firm prioritizes optimal fund size and excellent investment management for limited partners over maximizing fees. The firm maintains its structure as a private partnership in perpetuity, emphasizing long-term stability and adherence to core principles.
Sequoia's International Investment Experience, Particularly in China
Sequoia's experience in China illustrates the complexities of international investment amid geopolitical tensions. The firm recently split its Chinese business (now called Hongshan) due to growing U.S.-China tensions. The impact of regulatory uncertainty is evident in China's dramatic decrease in new company formations, dropping from 51,000 in 2018 to just 1,200 in 2023.
Sequoia's Strategy of Long-Term Holding and Compounding Investments
Since 2022, Sequoia Capital Fund has adopted a strategy of retaining shares in promising companies post-IPO. Botha reveals that this approach has generated an additional $6.7 billion in gains over three and a half years. Their investment in Natera exemplifies this strategy, where early involvement in 2007 led to continued ownership in what is now a $22 billion market cap company.
1-Page Summary
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Clarifications
- The Sequoia Capital Scouts Program is a unique initiative that allows talented individuals, often successful entrepreneurs or industry experts, to invest in startups on behalf of Sequoia Capital. These individuals, known as scouts, use their expertise to identify and recommend promising investment opportunities to Sequoia. The program has been successful in providing access to a diverse set of investment opportunities and has contributed to significant returns for Sequoia Capital. Scouts like Jason Calacanis and Sam Altman have been notable participants in this program, helping to discover and support successful companies like Uber and Stripe.
- A 26x multiple on investments means that for every dollar invested, the return is 26 times that amount. For example, if $1 million was invested and the return was 26x, the total return would be $26 million. This metric is used to showcase the success and profitability of investments in venture capital.
- "Return-free risk" is a term used in the context of venture capital to describe a situation where the abundance of available capital for investment does not necessarily lead to higher returns. It highlights the challenge faced by investors when there is a disconnect between the amount of capital available for investment and the quality of investment opportunities. Essentially, it means that despite the significant amount of money being invested, there is no guarantee of proportional returns, leading to a risk of not achieving the desired financial outcomes. This concept underscores the importance of not just investing capital but also ensuring that the investments made are strategic and yield profitable returns in the long run.
- Sequoia's structure as a private partnership in perpetuity means that the firm operates as a private entity indefinitely, without plans to go public or have a set end date. This setup allows for long-term stability, continuity in decision-making, and a focus on maintaining core principles over generations. The firm's commitment to remaining private emphasizes a dedication to its unique culture and investment philosophy without the pressures or constraints that can come with being a publicly traded company.
- Sequoia split its Chinese business due to increasing tensions between the United States and China, leading to regulatory uncertainties. This split resulted in the creation of a new entity called Hongshan. Geopolitical factors and regulatory challenges played a significant role in this decision. The split reflects the complexities and risks associated with international investments in regions affected by political and regulatory changes.
- Regulatory uncertainty in China refers to unpredictability and ambiguity in the rules and regulations governing businesses and investments in the country. This uncertainty can arise from sudden policy changes, unclear enforcement mechanisms, and geopolitical tensions impacting the regulatory environment. It can lead to challenges for companies and investors in understanding and complying with the evolving regulatory landscape, affecting investment decisions and business operations. The split of Sequoia's Chinese business and the significant drop in new company formations in China are examples of how regulatory uncertainty can impact investment activities and economic dynamics in the region.
- Sequoia Capital Fund's strategy of retaining shares post-IPO involves the fund holding onto a portion of the shares it owns in a company even after the company goes public. This strategy allows Sequoia to continue benefiting from the growth and success of the company in the public markets. By maintaining ownership post-IPO, Sequoia can potentially realize further gains as the company's value increases over time. This approach aligns Sequoia's interests with the long-term success of the companies it invests in.
Counterarguments
- The Scouts Program, while innovative, may not be solely responsible for the success of the startups it invests in; other factors such as market conditions and the intrinsic qualities of the startups themselves play significant roles.
- A 26x multiple on investments is impressive, but it may not be representative of the average experience in venture capital and could set unrealistic expectations for other firms or investors.
- The concept of "return-free risk" suggests a potential bubble in the venture capital industry, which could lead to a correction with negative consequences for investors and startups alike.
- While Sequoia's culture and investment approach are praised, they may not be universally applicable or successful for all venture capital firms, which operate under different market conditions and with different investment philosophies.
- Prioritizing optimal fund size and investment management over maximizing fees is commendable, but it could also limit the firm's growth potential and ability to scale its operations.
- Maintaining a private partnership structure ensures stability, but it may also limit the firm's ability to raise capital compared to publicly traded entities.
- The split of Sequoia's Chinese business could be seen as a retreat from a challenging but potentially rewarding market, and it may signal difficulties in navigating international investment landscapes.
- The decrease in new company formations in China could be attributed to factors beyond regulatory uncertainty, such as market saturation or changes in entrepreneurial activity.
- Retaining shares post-IPO as a strategy has been successful for Sequoia, but it carries higher risks as it exposes the firm to the volatility of public markets.
- The success story of Natera might not be replicable for all investments, and long-term holding can sometimes result in missed opportunities to capitalize on market highs.
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The Sequoia Scouts Program and Its Impact
The Sequoia Capital Scouts Program stands out as a transformative initiative in the venture capital space, enabling founders who lack personal wealth to invest in promising startups and consequently driving remarkable financial successes including investments in notable companies like Uber and Stripe.
Sequoia's Scouts Program, Started In 2010, Funds Founders Lacking Personal Wealth to Invest In Emerging Founders
Founded in 2010, Sequoia Capital's Scouts Program was initiated with the understanding that there existed savvy founders who were plugged into networks of emerging entrepreneurs requiring investment and advice, yet lacked the personal financial resources to support these ventures.
Sequoia Capital provided these founders with the necessary capital to make initial investments, which also positioned them to make further investments. Roelof Botha, representing Sequoia Capital, shared insights into how the program was conceived as a means to tap into the potential of these well-positioned individuals.
Scouts Program Led Sequoia To Investments in Uber and Stripe
The Scouts Program has led to various successes, notably Sequoia's investments in Uber and Stripe. Botha mentioned Jason Calacanis as a key ...
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The Sequoia Scouts Program and Its Impact
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Counterarguments
- The Scouts Program, while successful, may not be easily replicable due to Sequoia's unique position and resources in the venture capital industry.
- The success of the Scouts Program could be partly attributed to the overall market conditions during the time of its most notable investments, which may not be indicative of future performance.
- The program's focus on founders without personal wealth may still overlook other underrepresented groups in the startup ecosystem who also lack access to venture capital networks.
- The 26x multiple is an impressive figure, but it may not account for the full risk profile of the investments or the potential for survivorship bias in reporting investment successes.
- The success stories of Uber and Stripe may overshadow other investments that did not perform as well, which could give a skewed perception of the program's overall succe ...
Actionables
- You can start small by setting aside a portion of your income to create a personal 'scout fund'. Begin by saving a small, manageable amount of money each month specifically for investing in startups or small businesses that you believe in. This mimics the intention behind the Scouts Program, allowing you to support emerging companies even if you're not wealthy.
- Connect with local entrepreneurs and offer your unique skills in exchange for equity. If you have expertise in areas like marketing, coding, or design, approach startups and propose a trade of your services for a small stake in their company. This strategy allows you to become an investor through sweat equity, similar to how the Scouts Program empowers individuals to invest without upfront capital.
- Educate yourself on the basics of angel inv ...
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Current State and Challenges of Venture Capital Industry
The venture capital industry is currently navigating through a period of excessive investment, creating challenges in achieving sustainable returns.
Excessive Venture Capital: $150-200 Billion Annually, Unsustainable for Returns
The venture capital industry is investing between $150 to $200 billion each year. To sustain a reasonable return assumption of 12% per annum net, the industry would need to return $700-800 billion annually to investors. Given that venture capitalists do not own the entirety of the companies they invest in, this means the aggregate exit value should be north of $1 trillion each year.
Investment Viability Requires Unrealistic $1 Trillion Annual Exits
The requirement of $1 trillion in annual exits to meet return expectations highlights a significant challenge within the venture capital industry. The current level of investment implies a necessity for exit values that exceed realistic projections based on historical data and market conditions.
Capital Abundance Creates "Return-Free Risk": More Money, Not More Great Ideas or Founders
Roelof Botha suggests that the abundance of capital has led to a situation he describes as "return-free risk." This occurs because an increase in money doesn't correspond to an increase in the number and quality of investable ideas or founders. The industry is facing a bottlenec ...
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Current State and Challenges of Venture Capital Industry
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Clarifications
- In the venture capital industry, achieving a 12% return assumption means that investors aim to earn a 12% annual profit on their investments after accounting for fees and expenses. This return target is a common benchmark used by investors to assess the performance and attractiveness of venture capital investments. It reflects the risk-reward profile of venture capital, where investors expect higher returns compared to more traditional investments due to the higher risk involved in funding early-stage companies. The 12% return assumption serves as a reference point for evaluating the financial viability and success of venture capital investments.
- To achieve sustainable returns in the venture capital industry, the total exit value of investments needs to surpass $1 trillion annually. This figure is calculated based on the industry's current investment levels and the expected return rate of 12% per year. The high exit value requirement reflects the challenge of generating significant profits from investments in startups and emerging companies. It underscores the pressure on venture capitalists to identify and nurture companies that can achieve substantial valuations upon exit.
- In the context of venture capital, "return-free risk" describes a situation where the surplus of available capital does not guarantee profitable returns due to a lack of quality investment opportunities. This term suggests that despite the abundance of funds, the investments made may not yield the expected returns, leading to a risk of not achieving profitable outcomes. It highlights the challenge of deploying excess capital effectively in ventures that can generate significant returns, emphasizing the disconnect between the availability of funds and the scarcity of promising investment prospects.
- The disparity betwe ...
Counterarguments
- The assumption that a 12% return is a reasonable expectation may not account for changing market dynamics and the potential for higher returns in certain sectors or due to technological breakthroughs.
- The $1 trillion annual exit requirement may not consider the potential for a few extremely high-value exits that could significantly impact the return figures.
- The concept of "return-free risk" might be overly pessimistic, as venture capital is inherently risky and the industry has historically dealt with cycles of boom and bust.
- The assertion that more money does not lead to more high-quality investment opportunities may overlook the potential for capital to unlock latent talent and innovation, particularly in underfunded regions or sectors.
- The historical data on billion-dollar exits may not be a reliable predictor of future outcomes, especially in a rapidly changing technological landscape where new industries can emerge and grow at unprecedented rates.
- The need for 40 companies with Figma-like valuations annually may not account for the possibility of a ...
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Sequoia's Culture, Leadership, and Investment Approach
Sequoia Capital stands as a paragon in the venture capital industry with a culture steeped in balancing individual foresight with collective decision-making, and guided by respected leaders who have built a steady legacy of success along with a firm commitment to limited partners.
Sequoia Values Curiosity, Balancing Individualism and Teamwork, With Investment Decisions by Partner Consensus
Leaders like Doug Leone and Michael Moritz have had a profound influence on shaping the values and operational structure of Sequoia. Roelof Botha, a partner at Sequoia, emphasizes the firm's unique combination of individualism and teamwork, cherishing partners who exhibit insatiable curiosity and a compassionate nature. The firm's investment decisions are predicated on a consensus among all partners, exemplifying their commitment to collaboration.
Sequoia's Doug Leone and Michael Moritz Have Shaped the Firm's Culture and Success Through Their Leadership
Botha sheds light on the impactful gestures and imaginative foresight of figures like Leone and Moritz. For instance, Leone demonstrated his supportive nature through personal gestures, such as visiting Botha at home during tough times or when Botha's son was in the hospital. Likewise, Moritz showcased his visionary aptitude in foreseeing how companies like Yelp could gain significant recognition long before they did.
Both leaders have left a lasting imprint, with Moritz continuing to contribute advice even a decade after stepping back from day-to-day operations and Leone still actively involved in influencing the firm's key decision-making processes.
Sequoia Prioritizes Optimal Fund Size and Excellent Investment Management for Limited Partners, Not Maximizing Fees or Industry Value Creation Share
Sequoia's approach to investment is heavily concentrated on delivering the best possible outcomes for their limited partners, emphasizing the maximization of net internal rate of return (IRR) a ...
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Clarifications
- Limited partners in venture capital are investors who contribute capital to a venture capital fund. They are not involved in the day-to-day operations of the fund but provide the financial resources for investments. Limited partners typically include institutional investors, high-net-worth individuals, and other entities seeking exposure to the potential returns of venture capital investments. They receive returns based on the fund's performance, with the fund managers responsible for making investment decisions on their behalf.
- Net internal rate of return (IRR) is a measure used in finance to evaluate the profitability of an investment. It calculates the rate of return that makes the net present value of all cash flows from a particular investment equal to zero. Net multiple for LPs is a metric that shows how many times the original investment amount has been returned to the limited partners after accounting for fees and expenses. These metrics help investors assess the performance and efficiency of their investments over time.
- A private partnership in perpetuity means that the partnership structure is designed to continue indefinitely without a set end date or a need to dissolve or reorganize after a certain period. This setup allows for stability, consistency, and long-term planning within the organization, ensuring that the partnership can persist across generations without the need ...
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Sequoia's International Investment Experience, Particularly in China
Sequoia Capital's experience in China, which spans over two decades, illustrates the complexities and shifting landscapes of international investment in the face of geopolitical tensions and regulatory challenges.
Sequoia's China Business Splits Amid Geopolitical Tensions and Regulatory Uncertainty
Roelof Botha, Jason Calacanis, and Chamath Palihapitiya discuss Sequoia's historical business ventures in China and the current constraints faced by venture capitalists in the region.
Sequoia Capital entered China in 2007, the same time China joined the World Trade Organization, which initially sparked optimism for globally interconnected systems and companies. However, the growing geopolitical tensions and the division between the U.S. and China caused Sequoia to separate its Chinese business. Sequoia China became an independent entity called Hongshan.
Despite these challenges within China, Chinese entrepreneurs continue to thrive on a global stage. They are actively engaging in business operations in various regions including Latin America, Singapore, Japan, and Europe. This global expansion showcases the resilience and adaptability of Chinese entrepreneurial ventures amidst a turbulent home environment.
China's New Company Formation Drops From 51,000 in 2018 to 1,200 in 2023: A Warning on Policy Certainty's Role in ...
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Sequoia's International Investment Experience, Particularly in China
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Counterarguments
- The decline in new company formations in China could be attributed to factors other than regulatory uncertainty, such as market saturation, economic cycles, or a shift in entrepreneurial focus to different types of business models that may not be captured in traditional company formation statistics.
- The global expansion of Chinese entrepreneurs might not solely be a sign of resilience but could also be driven by a search for more favorable business environments or diversification strategies in response to domestic challenges.
- The separation of Sequoia's Chinese business could be seen not only as a response to geopolitical tensions but also as a strategic move to localize management, decision-making, and to potentially capitalize on local market insights more effectively.
- Policy certainty is important, but it is not the only factor that fosters a robust environment for ent ...
Actionables
- You can diversify your investment portfolio by exploring international markets, mirroring the global expansion of Chinese entrepreneurs. Start by researching emerging markets and industries with growth potential, such as tech startups in Latin America or fintech companies in Singapore. Use online platforms that provide access to foreign investments, ensuring you understand the risks and legal requirements involved.
- Enhance your business adaptability by creating a contingency plan for regulatory changes. If you're an entrepreneur or small business owner, assess how shifts in policies could impact your operations. Consult with legal experts to understand potential scenarios and develop strategies to pivot your business model or product offerings in response to new regulations.
- Educate yourself on the importance of policy certainty ...
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Sequoia's Strategy of Long-Term Holding and Compounding Investments
Sequoia Capital Fund has developed a strategy of long-term holding and compounding its successful investments, translating into considerable financial gains over the years.
Sequoia Capital Fund Holds Successful Investments Longer
Roelof Botha emphasizes that since 2022, Sequoia Capital Fund has consciously chosen to hold onto shares in companies they believe will continue to appreciate over the long term. This strategic shift required the creation of a fund structure that permits them to transfer shares into the Sequoia Capital Fund following an IPO, at intervals of 6, 12, or 18 months. This process avoids distributing these shares to Limited Partners (LPs) who might otherwise be inclined to sell them prematurely.
Sequoia Gains $6.7 Billion From Retaining High-Performing Shares Over 3.5 Years
This method of retaining shares and practicing patience has been rewarding for Sequoia. Over the last three and a half years, by not liquidating their shares, Sequoia has realized an additional $6.7 billion in gains. This substantial financial outcome demonstrates the compounding benefit of Sequoia's investment strategy over time.
Sequoia's Early Involvement Justifies Continued Ownership Beyond the IPO
The case of Sequoia's investment in Natera showcases th ...
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Clarifications
- The fund structure mentioned involves Sequoia Capital Fund transferring shares into their fund after a company goes public, at specific intervals like 6, 12, or 18 months. This process allows Sequoia to retain control over these shares instead of distributing them to other investors who might sell them early. It's a strategic move to hold onto promising investments for longer periods, aiming to maximize returns through sustained growth and compounding benefits. This approach reflects Sequoia's confidence in the long-term potential of their investments and their commitment to strategic investment practices.
- Limited Partners (LPs) are investors in a private equity fund like Sequoia Capital Fund. They provide the capital for the fund's investments. In this context, LPs typically receive distributions of shares or profits from successful investments made by the fund. Sequoia's strategy involves retaining shares in successful companies to prevent premature selling by the LPs, allowing for potential long-term growth and value creation.
- Sequoia Capital's investment strategy involves holding onto shares in companies for extended periods post-IPO to benefit from long-term growth, unlike traditional approaches that often involve selling shares shortly after an IPO. This strategy allows Sequoia to compound their gains over time by retaining successful investments. Sequoia's focus on early involvement and deep understanding of companies like Natera justifies their continued ownership post-IPO, showc ...
Counterarguments
- The strategy of long-term holding assumes that selected companies will continue to grow or at least maintain their value, which may not always be the case due to market volatility, changes in industry dynamics, or company-specific issues.
- Sequoia's approach may not be suitable for all types of investors, particularly those who require or prefer liquidity, shorter investment horizons, or who are risk-averse.
- The success of Sequoia's strategy is partly contingent on their ability to pick winners consistently, which may not be replicable by all investors or even by Sequoia in different market conditions.
- The $6.7 billion gain from not liquidating shares is a retrospective view; it does not guarantee future performance and may not be indicative of the outcome of other investments.
- The strategy requires a fund structure that can accommodate long-term holding, which may not be feasible or desirable for all investment funds, especially those with a different investor mandate or those that require regular distributions.
- Sequoia's early involvement in a company does not inherently justify continued ...
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1-Page Summary- The Sequoia Scouts Program and Its Impact
- Current State and Challenges of Venture Capital Industry
- Sequoia's Culture, Leadership, and Investment Approach
- Sequoia's International Investment Experience, Particularly in China
- Sequoia's Strategy of Long-Term Holding and Compounding Investments
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