Special: Sequoia Capital's Investment Playbook (with Alfred Lin)

Well, 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, but it is the whole partnership that brings the weight of Sequoia to the table and helps those companies become legendary companies. And we couldn't have done that without the spectacular founders that we partner with. So the kudos goes to them for having the courage to start those companies and wanting to put a ding in the universe. Love it. Well, that is everything that we are going to talk about here today.

Well, I think it all started with Don thinking about the market. I think the thing that we look for is a combination of a great founding team and a great market. And great founding teams find great markets or they find a wedge into that market or they find what's wrong with the market and then they discover that there's a problem that the world has gotten wrong and they want to go fix that problem. And we've always had to sort of listen to founders because they come from the problem of solving their own pain and they may not be thinking about the market per se. They're thinking about the problem that they have. And so to pair up and to work with and partner with these great founders, we had to come prepared thinking about the market and thinking about what the market can become because nobody's going to sort of wake up one day and suddenly know, oh yeah, lots of people were going to share their bedrooms or their 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, but you do have to sort of think about this from a perspective of being prepared and thinking about both the market and the ability of the market to grow and change. We often talk a lot about prepared mind because chance favors the prepared mind as Louis Pasteur would say. And when Jim got joined Sequoia, he had identified a lot of interesting areas to invest in. And you know, he pioneered some of our thinking of having landscapes and having a prepared mind for the mobile landscape for the rise of the developer and he would work and try to understand the landscape of what 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. In if you wanted to sort of think about in Airbnb's case, Greg McAdoo had been thinking about time shares and vacation rentals for a long time because it was kind of weird that hotels were slowly being aggregated and they were sort of being aggregated onto global online travel platforms. But that wasn't quite true with time shares and vacation rentals to the same extent. And it didn't lead necessarily immediately to an investment, but it gave us a sort of prepared mind on localized listings didn't really exist. BBOs and HomeAway, which made most of its revenue from advertising rather than booking it and the transaction itself. So when we saw Airbnb, it's like a completely different vector and a different way of thinking about the business. And 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. And we met with GrubHub, we met with Caviar, we met with Postmates and each time we passed, not because we were uncertain about the market size, we're actually we 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. And when we met Tony that was the combination we saw. He had a differentiated approach and the differentiation for him was the strategy of focusing on the merchants and in the suburbs. And the thing that he also brought was his keen eye for operations. And so we unfortunately decided to pass on the seed and then that's my fault. It took time for us to sort of 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 and we invested in their Series A and in every single round after that. And as you think about the way that you had previously thought about this food delivery market, the way that you know Greg had been thinking about the time share market and all that was wrong with it and aggregating it.

Yeah. So I think the answer, the simple answer is there's no straight formula for any of this. I think the way that it has bubbled up has come through because we identify a trend through just reading. We're curious about vacation rentals. We start reading about it. We start digging into it and nothing may come out of it for that particular point in time and then later on it becomes more important. It can be a full-blown landscape that you sort of 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? And it could be anywhere in between. Mention it to your partners. What do you think about this idea? What do you think about that idea? We have blue sky sessions every quarter where we just try to dream. This business is about inspiration just as much as about preparation. We need to both hustle, but at the same time, we need to be able to sort of think and be inspired about the world. And 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 riffing on the idea with us and we go deep with them as well as go deep with other founders who are in that space trying to sort of make sense of what's going on. And so I think the sort of 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 and we have people who love to be proactive and think structurally and we have partners who love to be in the ecosystem meeting lots of people and riffing ideas with lots of people in an imaginary way and dream up ideas with others. So, this is a business that you can do well with both someone who's an introvert as well as someone who's an extrovert.

The simple questions are you've heard before is why now? What many of these ideas have people have thought of in the past? It's not the first time that someone has decided that we should deliver food. In 1999, there was a company called Kozmo that opened up in New York. So, 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 then there are times when there's not a good why now. And in Instacart's case, or in 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 a sort of an on-demand workforce was not available in 1999 because not everybody was carrying a mobile phone. So there are sort of situations where you have good why now for a particular company to be able to sort of take off. The other question we ask all the time is in 10 years why who cares about this company? Don used to ask who cares? And 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? And what does this company become 10 years from now? So imagination about that and what happens when everything goes right is really important. So 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 that it's quite easy to write the premortem of a company. What will go wrong? What are the major risks?

I think it's easy to sort of look back from now and it was obvious at the time it was not always obvious. And I think what they will articulate is that people should do this this way. The way I view the future is a far superior future. And I think that that's the dream that you have to be able to riff on and whether if that's the future, can you build a really large company? And 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 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. And both can happen. And we generally like the more non-obvious markets where there are good tailwinds and 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 and so you know I'm not saying that you know competition is not going to happen in any company like 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 but I think for a startup you kind of 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. And so you need areas of white space. You need a market entry strategy where people think, you know, you're that little company. Oh, wow. You know, that's kind of cute. Go ahead. You can take that. You know, in Innovator's Dilemma, they talk about all the low margin stuff. They always the big companies always give the low margin stuff to the startups because the startups yeah who cares not a lot on margin and that they get really, really good at that because they figured out how to make money with low margin and they go up market to the higher margin stuff and then eventually they overtake the industry. That is one way obviously of entering a market. There are other ways of entering the market just with a superior product. So you get more and more people to sort of talk about you and you know if it's 10 times or 20 times better product then everybody's going to talk about you and we'll migrate to you. There are other ways by having a completely different strategy. If you think the everybody thinks this is a feature it may be someone else's bug. Not everybody is the same. You're not going to capture 100% of the market in something as big as travel. But it's the ability to differentiate yourself from a current trend sometimes that makes you successful. And I think in both Airbnb's case and DoorDash's case, that is exactly what happened.

It has a lot to do with the sponsor in Airbnb's case, Greg, and in DoorDash's case, me sort of painting a picture of the world that and showing the conviction of why you believe that this is going to be the case. And it happens over and over again, right? Like if you might be an investor in the seed like we were in Airbnb and then in the A you still have to sort of paint the picture again and maybe is it bigger? Sometimes these companies it's easy to dream with them because they every single point along the way they've outstripped everybody's expectations. Not just because there's more usage or more revenue, but the sort of the way the world has reacted to the company is just phenomenal. You know, we just Doug Leone used to always say, don't fight the tape. And sometimes the evidence is just in the tape where like they just keep growing, they keep doing well, they attract great talent, people love the service, and they continue to sort of 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 single pixel of their website in Europe. And they decided that they wanted to win Europe. And 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 decide to do that and won. And so like 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.

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. And 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. And what is true is that you want to travel to different parts of the world and more than you do locally. And if you win that, if you win the supply, you will most likely get all the demand. And that was the reason why we had conviction on investing more in later rounds.

I think part of dreaming is that you can create one. It's not that we it's not that it got realized on the first on our seed investment. At the seed investment they had a listing service, right? They had 2,000 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 sort of concept of a marketplace has been around for a while, 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. And so 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.

That's a great question and I think the reason why there's a lot of passes on market size is you know 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 and it is good advice and it's not advice that I often talk about with founders because I think the one thing that is a little different at the early stages is that you're going after non-obvious markets. So if you go after an obvious market as we talked about and there it's a very large market, there's intense competition because it's obvious. And then 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. And that's how I kind of would like to have that conversation with the founder. Why is this market going to be large in the future? And 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. And then we work with the founders to sort of think about it. And 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 start phone, but the user experience wasn't great. And so mobile really started to take off because the smartphone started to take off and it was a full functioning computer. That sort of was what carried mobile through for many, 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 kind of see that more and more software is going to be written and put in the cloud. You know, it took AWS coming around where developers are starting to build 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, you know what, it lowered the cost of starting a company. A developer Jim Gatz who talked about having a prepared mind. He 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 sort of 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 and start coding and put it on AWS. And so you could see that that was going to be a trend for some period of time. There's that amazing moment that we talked about in the Airbnb episode where the YC startup school where Bezos sort of launched AWS to startups was the startup school that Brian, Nate, and Joe went and attended before they did YC.

Yeah. And again, like you know those are the type of things that you know these little things happen and then you realize it's going to unlock an explosion because otherwise Brian, Joe, and Nate would have had to rack their own servers, right? Like that's for them that's no fun because they're two designers and someone who wrote code and 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 be particularly happy doing that they want to dream about what

Yeah, exactly. Those trends that carry you are quite important. You know, I often talk about there are three components of a pitch and some founders do all three well and most founders do the first one well which is like what's your vision of the world and so the beginning is 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's going to be different. Then you have the realities of today. Paint the pictures of what's going on and 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 answer is nuance. I think high gross margin, as Bezos would say, it's 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. So, you need high repeatability. And the notion of gross margin is a strange thing. If you look at Door Dash 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. And 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. And so 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 sort of 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. And the confusion I think 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's and I said, 'Hey, there's just too much money in the venture ecosystem.' He's like, 'Yeah, thanks for observing that, you know, go back to work and your job is to figure that out.' And 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? 10 years before you, there was too much capital. And 20 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. And the thing that we've learned over time is that the winners get a disproportionate amount of the market cap. And if that's true, then they also will, by just simple logic, investors then want to invest in the winners. And so the winners get more and more of the capital. And if there's more money in the system today, the winners will get more money. And that allows them to do things slightly differently. And I use the sort of case where in e-commerce when I was at Zappos, we needed to make sure that the payback on the CAC was on the first order. Well, I don't think any company today in e-commerce does that. If you have more capital, if you know it works on the first order, then if I give you a little bit more capital, maybe you can extend it to 7 days or a month or, you know, 6 months or a year. I do think that this transitive property doesn't always work. You know, it's not like if it works with zero cap, you can do it for, you know, a year, two years, 3 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's more willingness to see unit economics pay back over a longer period of time if the market is large.