“Don Valentine participated in the beginnings of two significant milestones: the birth of the silicon chip and the development of the venture capital industry. From humble beginnings, Valentine became a legendary salesman at Fairchild Semiconductor and National Semiconductor, before founding Sequoia Capital in 1972.” He “was one of the original investors in Apple Computer, Atari, LSI Logic, Cisco Systems, Oracle, and Electronic Arts.”
1. “[Venture capital] is all about figuring out which questions are the right questions to ask, and since we don’t have a clue what the right answer is, we’re very interested in the process by which the entrepreneur get to the conclusion that he offers. Our business is a business of highly intuitive decision making and that fact that it’s done in a scientific area doesn’t make it scientifically practical to make decisions that way…”
“We recognize by Socratic questioning opportunities that are better than others and why.”
“The art of storytelling is incredibly important. Learning to tell a story is critically important because that’s how the money works. The money flows as a function of the story.”
Michael Mauboussin points out in one of his wonderful slide decks: “The best in all probabilistic fields: 1) focus on process versus outcome and 2) always try to have the odds in their favor.” If you read the many posts in this series on my blog you will see that all great investors focus on having a sound process. A great venture capitalist like Don Valentine learned early in his career the importance of having a sound investing process.
When you are in a business driven by optionality, like the venture capital business, investing a lot of resources in creating spreadsheets is a waste of time since the assumptions in it are guesses. The best way to quantify the opportunity is actually with a story. Chris Sacca puts it this way: “Good stories always beat good spreadsheets….Before drawing a single slide of your pitch deck, tell the story out loud to anyone who will listen. Again and again. Now you have your deck.” My father’s twin brother recently passed away and at his funeral one of his sons talked about how his dad liked to tell Ah Mo: Indian Legends from the Northwest stories collected by my great grandfather. My uncle knew well that the best way to get good at telling stories is to actually tell stories. He was also a great teller of jokes.
Telling stories is like public speaking: the more you do it, the better you get. If you must to refer to notes in telling your story, it will be vastly less effective. Speak from the heart in telling your story and you can say a tenth as much but have twice or more as much impact. Sometimes I meet an entrepreneur who reminds me of an Maya Angelou quote in I Know Why the Caged Bird Sings
2. “I’ve always been mystified by the critically important disc drive industry, without which the PC is a useless device. You have to be brilliant in electronics, you have to be brilliant in magnetics and you have to be brilliant in mechanics to get all that memory capacity in a very little place and do it for next to nothing. That market has never been rewarded financially for its brilliance.”
The reason for this “mystery” described by Don Valentine is best explained by Charlie Munger: “there are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that’s still going to be lousy. The money still won’t come to you. All of the advantages from great improvements are going to flow through to the customers.” At its heart, what Charlie Munger is taking about here is the importance of a moat. If a business does not create some barrier to entry, supply will be increased by competitors to a point where profit drops to the opportunity cost of capital.
Don Valentine is pointing out that many things which require sheer brilliance to create technically produce only consumer surplus and no producer surplus (profit). The level of profit of businesses in a given part of the economy can be vastly lower than their importance to society. For example, airlines and many manufacturers generate a lot more value to society than their profitability suggests.
3. “We have always focused on the market — the size of the market, the dynamics of the market, the nature of the competition — because our objective always was to build big companies. If you don’t attack a big market, it’s highly unlikely you’re ever going to build a big company.”
“Great markets make great companies.” “We’re never interested in creating markets – it’s too expensive. We’re interested in exploiting markets early.”
“I like opportunities that are addressing markets so big that even the management team can’t get in its way.”
Do startups sometimes create new big markets? Sure, but Don Valentine is saying is it too expensive for his taste. The other point he is making is similar to a point made by Warren Buffett: “When an industry with a reputation for difficult economics meets a manager with a reputation for excellence, it is usually the industry that keeps its reputation intact.” Don Valentine is saying that even a subpar management team can win in a market that is really big that is exploited early. And, of course, a first rate management team in that same situation will do even better.
4. “The key to making great investments is to assume that the past is wrong, and to do something that’s not part of the past, to do something entirely differently. I asked what was the most outrageous thing you’ve ever done, knowing in my heart of hearts that I’d pick the one who’d done something most outrageous.”
“What is important is to have the ability and willingness to be different. Great companies are built with different products by different people.”
To make a dent in the universe, it will be necessary to be contrarian on something very important and be right about that contrarian view in a big way. This is true both in investing and in building a business. No one speaks more clearly on this point than Howard Marks. I’ve blogged about that here. No one has taught me more about this than Craig McCaw, who is about a different a thinker as I have ever met. Don Valentine’s partner Michael Mortiz said once: “While there is danger in the venture business in getting too far away from the crowd, it can often pay to be unconventional. Don Valentine, the founder of Sequoia Capital, told me to trust my instincts, which lets you avoid getting dragged into conventional thinking and trying to please others.”
5. “The trouble with the first time entrepreneur is that he doesn’t know what he doesn’t know. After a failure, he does know what he doesn’t know and can beat the hell out of people who still have to learn.”
A famous Confucius quote is: “True wisdom is knowing what you don’t know.” But the important corollary to that quote is that there are some things that you can’t know, because some future states of the world are not known. A similarly famous Don Rumsfeld quote is: “As we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns — the ones we don’t know we don’t know.” Risk comes from not knowing what you are doing and big problems can come from not knowing what you don’t know.
I have done a few posts on the work of Zeckhauser and Taleb that you can read on this point (e.g., #1 here).
6. “The biggest consistent irritant were co-investors more intent on talking over management, rather than listening to them, in the board room.”
“The world of technology thrives best when individuals are left alone to be different, creative, and disobedient.”
Board members who thrive on helping others succeed are the right sort of board members to have. Board members who love to listen to themselves talk are a disaster. They are the equivalent of the people in the gym who love to stare at themselves when they work out. You might say that there is an inverse relationship between the need of a person to take selfie’s and their suitability to be a board member.
7. “There are two things in business that matter, and you can learn this in two minutes- you don’t have to go to business school for two years: high gross margins and cash flow. The other financial metrics you can forget… with high gross margins you can grow the company as fast as the market will allow.”
“All companies that go out of business do so for the same reason – they run out of money.”
Cash is like oxygen or water. Without it you are dead. A lot of things will be forgiven in business, but running out of cash is not one of them. Particularly in a subscription business you can have a huge mismatch between profit and cash flow. Expense can be stacked up in month one and cash coming in only over a long time. “The only unforgivable sin in business is to run out of cash” said Harold Geneen. The markets seem flush with cash right now. But that availability of new cash can disappear in a heartbeat.
8. “These binders cost money. Spend it on something more useful.”
Don Valentine is a believer in cost control and sending messages by walking the talk. Give him something like a report in an expensive binder he is going to say something like “this is not a good way to create value.” Famously frugal managers like Tom Murphy are not opposed to spending money as long as it creates value. One thing that people underestimate the importance of is the need to acquire customers in a cost effective way. Acquiring customers cheaply is such a beautiful way to make generating a profit easier. Conversely, paying too much to acquire a customer is not a solvable problem. The cost of acquiring a customer and the cost of serving a customer can be stone cold killers of a business.
9. “We don’t spend a lot of time wondering about where people went to school, how smart they are and all the rest of that. We’re interested in their idea about the market they’re after, the magnitude of the problem they’re solving, and what can happen if the combination of Sequoia and the individuals are correct.”
One of the most attractive things about the venture capital world is that someone without credential x or y can still become a success. That is not to say that credentials are not relevant or helpful, especially early in a person’s career, but history has shown that at least they are not required. One of the very best credentials, of course, is previously scoring a very big financial return, most importantly for the person considering your proposal.
10. “One of my jobs as a board member has been to counsel management to avoid distraction and to execute with constructive paranoia.”
It is easy for a startup to lose focus. There are lots of “shiny new pennies” which people like journalists like to talk about that can cause distraction. Paying attention to what is actually going on in a business and avoiding distractions is essential. The importance of being paranoid is famously attributed to Andy Grove of Intel, who said once: “The ability to recognize that the winds have shifted and to take appropriate action before you wreck your boat in crucial to the future of an enterprise.” Don Valentine is saying that vigilance is important and that the right sort of paranoia is constructive paranoia.
My father-in-law loved to joke that “just because you are paranoid doesn’t mean they are out to get you.” Andy Grove once wrote: “Business success contains the seeds of its own destruction. The more successful you are, the more people want a chunk of your business and then another chunk and then another until there is nothing.” The bigger and more profitable you get, the bigger the X on your back serving as a target for competitors.
11. “Think about a company like Eastman Kodak – it was the leader in its market, and now it’s gone. How can a $100 billion company go out of business? The answer is, easily and quickly.”
When optionality driven by network effects pays off, the amount of that payoff in a digital world can be nonlinear. And when network effects disappear, the amount of loss and the speed it disappears is also nonlinear. In other words, network effects are a double-edged sword – success can disappear just as fast as it was created. Actually, the loss of network benefits is more spectacular since it is something huge transforming into nothing. When network effects create benefits the early success is unseen and more surprising since the phenomenon involves “emergence.” Something suddenly appearing in a way that is far greater than the sum of its parts can be surprising indeed.
12. “I just follow Moore’s Law and make a few guesses about its consequences.”
“The nature of silicon and software and storage go hand in hand. In the case of software, you just have to be more clever about the nature of the application. So all these things kind of tick along, feeding off each other.”
Don Valentine’s partner at Sequoia Michael Mortiz once said: “A chimpanzee could have been a successful Silicon Valley venture capitalist in 1986.” It’s been very good to be associated with Moore’s law over the years. Underestimating Moore’s law’s power is easy to do since its impact is nonlinear. Humans are not well equipped to understand nonlinear phenomenon well since most things in life are linear.