E750: LAUNCH Angel Summit: Alfred Lin Sequoia on mission-driven founders, seed stage strategies, AI

This week in Startups is brought to you by PayPal. PayPal is awarding three businesses with $10,000 and a makeover from one of their partners. Believe you have what it takes? Visit paypal.com/twist to learn more and enter by July 30th. And Cisco Spark. Get video meetings, team messaging, digital whiteboarding, file sharing, and calling all in one secure app. Visit ciscospark.com to learn more and sign up for free. In today's episode filmed at Launch Angel Summit, Sequoia partner Alfred Lynn talks with Jason about backing mission-driven founders, seed-stage strategies, the future of AI, and more.

So we got involved with Zappos. It's sort of a fluke. We raised a small seed fund from friends and family of LinkExchange and started investing, and we started it called Venture Frogs. Venture Frogs. Incredible branding. People confuse it with venture fraud. So right, we had a friend, Kammy Hayashi, who we really wanted to recruit to run the incubator for Venture Frogs, and she loves frogs, and she said, we dared her, like, we'll name the firm Venture Frogs if you join and run the incubator. And so that's how we recruited her. And you know, Venture Frogs is actually kind of a cool name. It's green. It hops from lily pad to lily pad. It's certainly memorable. Certainly memorable. Yeah. So we started investing, and one of the companies that we invested in was Zappos, and so that's how we got started. We started this fund in 1999. It was probably the worst time to start a fund. Partly, today you have it might be very heated in terms of valuation, but there was a lot less support back then. If you're going to run a seed fund, you're going to have to help the company get from seed, help them build, help them recruit, and get them funded with very little support from anybody else. There wasn't a band of angels back then as there is as much as there is today. So we made 27 investments. One of them was ASG, one of them was OpenTable, one of them was Tellme Networks where Todd and I worked for a period of time, and one of them was Zappos. The reason we ran the fund for a year — it was supposed to be a three-year fund — we basically invested the whole fund, made 27 investments. And when 2001 happened, when the internet was overhyped, it caused us to look at our portfolio and say, which companies can we help? Which companies are going to not do well regardless of how much we helped? And the two companies we thought we could help a lot was Tellme Networks and Zappos. So that's how we got involved with both companies. Tellme was losing $60 million a year. I went to that company first. Tony went to Zappos. And then I joined at Zappos in 2005.

The fund was $27 million. So on average, we made 27 investments, average was a million dollars per company. So it was a high conviction, concentrated bet fund. It wasn't a we're going to make 50 or 100 investments and hope that some of them will do well and then double down from there. We were very targeted and specific. The range of investments were $100,000 to — for Zappos it was $2 million.

Well, in 1999, if you look at the Cambridge study, if you return capital, you're in the top decile. That's pretty bad performance in my opinion. We returned 7.5 to 8x after fees and carry. Wow.

Zappos was about 20 people when we invested, or no, probably 10 to 20 people when we invested. Tony joined them probably when they were around 30 people. And when I joined, it was about 300 people doing about $300 million in sales. And when we sold the company, when the deal was done, it was $1.6 billion in gross sales and about 3,000 people.

The sale was convoluted. So a little history about Amazon in the 1999-2000 era: Amazon did make a few acquisitions, most of them did not work out, they paid high prices, and so for a long time they didn't do any acquisitions at all. And he came down probably in 2005 with his team — it was Jeff Bezos, Jeff Blackburn, and Russ Rimenetti, I believe, maybe one or two other people, but I think that was it. We didn't want to meet at Zappos headquarters, so we went to a hotel nearby in a hotel room. And our contribution was we brought two pizzas for his famous two-pizza team thing. And we started talking. What we wanted to do at the time was we were having fun running the company. We wanted to continue to run the company, but he wanted to buy the company as opposed to partner. So that first interaction didn't go anywhere. And then the second time, it just kind of happened naturally because we had been talking for some period of time. Peter Krawitz, who was the VP of corp dev at Amazon, mainly did the deal. When we decided to do the deal, we had dinner with Peter and Jeff Blackburn, and we started talking about how we really still wanted to run the business separately from Amazon. Would they be okay with that? We talked about our culture being different from Amazon, brand being different from Amazon. There was a lot of negotiation around the structure before we even talked about price.

$1.2 billion on the day it closed in stock.

Did I keep the stock? You kept some. I kept some. Yeah. But what is it? It's an interesting question about when do you sell, because if we had kept Zappos the company, it would probably be four times as big as well. So it didn't grow as fast as Amazon stock. So the right choice was sell the company and keep the stock. If you could grow 9x as much, then you keep the company.

Well, the question is interesting because it really has nothing to do with the venture capitalist being on the board. It really has to do with the founder. Does the founder want to sell or not?

In most situations, if you believe you picked the right company, you have the right team, you're in the right markets, a lot of the questions around — do you have the 'why now?' Are the trends in your favor? — you should keep going. And it's easy for me to say this, but if you had a portfolio approach, your winners will way, way pay for all the losses. Like Google, like all the winners if you just hang on to them like Amazon, they will just pay for all the other losses. But I can say that as a person who manages a small but still a portfolio of investments, versus a founder who only has one asset. So I think there is the risk-reward element. That's why secondaries have become an element of conversation. Some investors don't like it.

Well, it allows them to keep going. Otherwise, you would have exits a lot earlier, which benefits the investor from a liquidity standpoint, but if you believe you have a great asset on your hands, you should just keep going and hold on to it.

You have to look at the motivation of a founder. If they're on a mission, as Shantel was saying, they're not going to suddenly have a little bit of money and then not want to be on the mission. If they're a mercenary, they might have enough money and say, 'Screw this. I can become an investor, an angel investor, start a fund. I'm going to have a better life.' And they stop working. Look, we all know people who stopped working when they made their first million. Is that enough to really retire? No. And you know people who stopped working when they made their first $10 million. Is that enough to retire after taxes? If you have $10 million, you don't want to live in the Bay Area. It's probably enough. And we know people who keep working when they have billions of dollars. Like, why does Elon work? He's running two companies. Mars, sure, but he's on a mission. If you're the type of person that is going to want some level of money and comfort and that's it, then you're done. I do think some of the secondary sales, the numbers are silly or ridiculous. So when you take up more than $10 million off the table, I do think that gets to silliness land.

Let's start with what I wouldn't do. Good. When we started, it was fun and it was a hobby, and it's fine if you want to do it as a hobby. That's perfectly fine. There are plenty of people who brew beer and make wine, and it's a hobby for them. They're not in it to make money. Then there are people who want to run a microbrewery to make money, and there are people who run wineries to make money. The analogy is somewhat similar because there are so many people in the angel business who are in it to say they're an angel investor, that they're in this company or that company. I think if you want to be a good angel investor, I don't know if 50 is the right number. You want to think about that. I think having high conviction around a few select companies and then helping those companies is a much more leverage way of using your talents, and also using just simple concentration of good companies over bad companies. I don't believe in indexing. When it comes to entrepreneurship, if you index, you're going to lose 80-90% of the time. I don't think most of you would invest in a fund that had a loss ratio of 80-90%. If the fund says their loss ratio was 80-90%, you wouldn't invest in that fund. So if you apply some first principles, you go back to: what do I know? What are my skill sets? What can I learn? Because my skill sets don't always apply to the next generation of stuff. Where are the areas I would like to work with? What skills do I bring to those founders and those companies? Going from the bottom up, I would say I'm an operator. I'm going to look for people who are technologists and product people. Most people in here would probably say the same thing, but I can really help put operations in place, help them run and think through running a company. So I look for those founders, and I look for founders who are on a mission but also thoughtful, very detailed about exactly why they want to go change the world in this particular area. Some founders have very surface answers on why they think this is a good market, but they really don't go deep. Now that people know to come to angel investors, seed investors, venture capitalists with a story of why they're on this mission, you really need to dig to see exactly how deeply they've looked into the industry and why they think they can disrupt it. My comment there is not product-market fit, but founder-market fit. Does a founder fit this market? And then in terms of trends, it's very obvious to a lot of us here that AI is going to change the world. AR/VR is going to change the world. Security is going to become a bigger issue. Those are areas I would certainly look at. Marketplaces continue to be more and more powerful because more people come online. Marketplaces is an interesting thing because the thesis is that once you connect disconnected, dumb things together, they somehow become smart and can transact. Airbnb is an example: those bed and breakfasts were not connected. They couldn't market to the whole world. If you're by yourself, you're disconnected. You can only market locally. That's not as powerful of a business because most locals don't need to stay at the Airbnb. But when you connect them, you can advertise that bed and breakfast globally, and then that business model makes a ton more sense.

That's multiple questions in one question. Let me just work through as usual, Jason. So we've been investors from early to IPO and beyond since 1972. We've learned a lot. There's a lot of tribal knowledge in the partnership, passed down from generation to generation. One of the things that makes Sequoia Sequoia is that we have a variety of people at different levels of experience in investing, from different backgrounds — sales, operations, finance, marketing — around the table. So when we look at the world, we hopefully get a 360-degree view of what's going on. You have people in their 50s who have great advice. Everybody says 'this time is different.' I've heard that X number of times. The question is not 'this time is different' — every single time is different — but 'why now?' Is this technology going to be transformative? The smartphone — that screen you have there — was it actually invented in 1972? People have been trying to get the touch screen to work since 1972. Until it got to that form factor, people didn't really care. It's interesting how long technology sometimes takes. There's going to be hype in certain cycles, and overhype in others, but sometimes technology just takes a long time to play itself out. So you want that history and knowledge. How do we think about the seed ecosystem? We are active in seeds, just like we have been. We were seed investors in Airbnb, Dropbox, and Palo Alto Networks was an incubator. So our check size starts from zero. We incubate companies. We have entrepreneurs we work with; they work with us in our offices. We do seeds just as selectively as we do Series As. And we do get outbid. You have to think through the risk-reward. I would in general say that price is less important in the early stage than it is in the growth stage. Entry valuations — if it's going to be a $1 billion, $2 billion, or $10 billion company, getting in at a $10 million valuation or $20 million or $100 million doesn't matter. The difference is if your fund is constructed so that your entry valuation is supposed to be $30 million and suddenly you're paying $60 million, you have half the number of shots, and you just have to be conscious of that. What does that mean for your portfolio? You're supposed to be constructing a portfolio to average out some risks. Do you feel comfortable with that? If you feel comfortable and have that much conviction that this company is going to do that well, we will invest. And we have a partnership for that reason. There are going to be people who are the sponsors and people who are the skeptics. And we make decisions based on unanimity. Everybody has to agree, because we want it to be a Sequoia company, not a Doug investment or Alfred investment or Roelof's investment or Brian investment. We think that's corrosive for the culture of the firm and bad for the companies you work with, because you only get access to that partner instead of the whole partnership. The strategy is to know that the world is competitive. There are people who are going to be your competitors one day and your co-investors the next day. It's co-opetition. We work together in certain situations as friendlies, and we compete in others. In some ways, we play our own game, adjusting to our tribal knowledge and as the market moves.

Yes, I started as a scout. We were both scouts.

I did Uber, Flipboard, a few others. I don't remember. So we were in the first class before you joined full-time.

Originally, the scouts program was just an extension of Sequoia. We have founders who said to us, 'Hey, we get pretty good deal flow. I'm just sending it to you.' There were too many companies going through our CEOs and founders, but they couldn't take any action because they were 100% committed to their company, and their whole net worth was tied up in that company. So we created this program. Roelof came up with the idea of giving a select group of founders and CEOs in our network an allocation to invest in seed and angel-level companies. The CEO or founder would work with those companies and at the right time tell us they're raising their next seed round or an A round, and we'd be able to jump on those companies at the right time. It worked pretty well. A number of companies came through you, Jason, like Thumbtack. What others? You've made the most.

Well, that led to me having my own fund, right? Eventually the training wheels came off.

Can you talk about some of the ones you passed on?

The anti-portfolio, as we say. For a long time, I was really pissed I passed on this company. The day I started, Mike Moritz sat me down and told me this is a really humbling business. I'm like, 'He's done so well, he can't be humbled by this business.' And he said, 'Well, I don't know many businesses where you can be right about the investment thesis and still lose a shitload of money, or be wrong about the investment thesis, completely wrong, and make a shitload of money.' It's worse than gambling. In Vegas, if you play a shitty strategy at blackjack, you'll lose all your money. If you play well, you'll still likely make money, but not a lot. It reminds me of 1999 when we were seed investing. There was a company called Confinity that came by, and this guy named Peter and Luke wanted to beam money from Palm Pilot to Palm Pilot. The reason I'm saying this is because the name was Confinity. They wanted to beam money from not that many devices to not that many devices. Our reaction was: person-to-person payment is really interesting, but why Palm Pilots? How many people have Palm Pilots? Maybe a thousand back then, maybe 10,000. Why don't you use email? We actually told them that. They said no, it's not an elegant solution, it's not secure, harder to secure. They went off, and we passed because our investment thesis was that person-to-person payments is interesting, but this method of distribution was not okay. Then there's a company called X.com that starts with the idea of email. The Confinity guys are like, 'Well, I guess we have to do that email product.' They start it as a side project, leave it alone, and focus on their Palm Pilot beaming. Then they see it keeps growing and discover the email product is way better. So if you had the vision to see that a company could pivot in that same space to something different, you would have invested and made a lot of money. If you didn't, you would have been wrong.

Oh, I think more. $100 million mistake.

Right. Because eBay went 20x from there.

Question on the scout program. Is that something you're only doing in Palo Alto, or are you thinking of doing it in other cities? What's your thought on that?

We're doing it primarily in the Bay Area and some in New York.

How do you think about India and China? Has it gone well for you there? And I think you also have Israel, right?

Yeah. We have a global platform. We believe in cross-learning globally but investing locally. I work on the US fund. We have partners with similar structures and systems. We use the same formats for memos and one-pagers, but locally, our China team runs their business and invests locally. Our India business does the same, Israel the same. The returns have been great. The cross-learning has been great, and the ability to help a US company get into China is great. The ability to get Israeli technology out of Israel to the US or into China has been great. India and China are collaborating more than ever because they have very similar problems with large populations and a rising middle class. So they invest in things we wouldn't invest in as much in the US, with the trend of the rising middle class. It's been great.

Great question. I don't know. I think the venture space has largely not changed all that much. There's a lot of money coming in at the seed level, but not a lot of venture firms being created. The idea that angel firms will disrupt venture firms — there's a possibility of that. We think about that all day long. If entrepreneurs only want cheap money and a network, if you get a band of angels together, they have a network and power. Our value-add at venture firms is helping with the 10-year journey. In terms of co-opetition, you want both. You want the seed ecosystem to help a company get off the ground, give them a chance, provide them with the best chance of hiring a few people and getting the product made to validate a product need. Then we go from there. Maybe venture firms take less risk because the companies are more mature, and it's fine because we don't have to have as high a loss ratio as before, even if we pay in at a higher valuation. The ecosystem — you graduate from seed to venture, from venture to growth, from growth to late-stage growth. That has existed for many decades, and I think it will preserve. The players and how we play at each level may be very different and evolve as the world evolves. We all have to evolve.

How do you answer that question for Airbnb? What's the AI-only version of hospitality? How would you see that coming together?

He's really smart. He's on a mission and he's committed. This is his life's work. His capacity to look through a problem and get to the root cause or the issue at hand — the first-order issue — is just lightning. He gets to the issue very, very fast. And he's a fierce competitor. I have enormous respect for him. Going back to people with billions and billions, none of these people who run these companies have to work. But they all work extremely hard.