Roelof Botha is a partner at the venture capital firm Sequoia Capital. He has been involved in many businesses. He also writes: “Some democratize technology access (Square, Eventbrite, Unity); some create global user communities (YouTube, Tumblr, Instagram, Whisper, QuizUp); and others disrupt markets through innovative business models (Evernote, Weebly, Xoom).” In 2000, prior to his graduation from Stanford Graduate School of Business, he was a director of corporate development for PayPal. He was named CFO in September 2001 and after the PayPal IPO joined Sequoia in 2003.
1. “The key characteristic [of a founder] is the desire to solve a problem for the customer. That is the driving passion, not ‘I think this is going to be a billion-dollar company and I want to hop in because I can get rich.’”
“I look for the personal passion of the entrepreneur, their ability to describe the problem articulately, and the clarity with which they can explain why they have a unique and compelling solution to the problem.”
“The most successful entrepreneurs tend to start with a desire to solve an interesting problem—one that’s often driven by personal frustration.”
If a business is not solving a genuinely valuable problem for customers nothing else matters and failure is inevitable. Founders who are thinking about revenue models, term sheets and lots of peripheral issues when the business is not yet solving an important and valuable customer problem are missing the boat. In making these statements Roelof Botha is expressing a desire for missionary founders over mercenary founders. Botha’s partner Doug Leone also favors missionary founders. John Doerr of KPCB also feels the same way about missionaries being preferable to mercenaries. For the same reason, Brian Chesky of AirBnB once said: “in a war, missionaries outlast and endure mercenaries.”
On a related point, Roelof Botha has said that he thinks many great companies sell out too early. He has said that Sequoia “loves being in business with entrepreneurs that want to build something enduring.”
2. “There is a 50% mortality rate for venture-funded businesses. Think about that curve. Half of it goes to zero. There are some growth investments—later stage investments—which makes things less drastic. Some people try for 3-5x returns with a very low mortality rate. But even that VC model is still subject to power law. The curve is just not as steep.”
Venture capital requires outsized tape measure home runs to be successful because of the failure rate. A few giant winners must make up for many failures. Basic mathematics dictates this requirement. You can’t have failure rates that reflect a power law without huge returns from so-called “unicorns.” The need for unicorns drives the selection process of venture capitalists. This fact of life in the venture business means focusing on big markets and businesses that have the potential to grow revenues and profits at nonlinear rates. Most businesses that are formed are not candidates for venture capital. That’s OK. The best way forward for a business which will never have revenue above $100 million may be bootstrapping with internally generated cash, business loans or investments from friends and family.
3. “Entrepreneurship is much more than what VCs participate in.”
Many businesses described by founders as needing venture capital are really just small businesses looking for what amounts to small business finance. The people who start these businesses are genuine entrepreneurs. Often they are better off with bootstrap financing or borrowing money in the form of a loan. The businesses created by these entrepreneurs are very important businesses, and a key part of building an economy and creating jobs. But they are not the sort of businesses that are suitable for venture investing. Again, that’s OK. the total amount of venture financing is overall a relatively small part of an economy. Because of its impact on innovation and productivity venture capital punches far above its weight in terms of impact, but the absolute dollar amount invested per year is relatively small.
4. “Think of yourself as the central point of a network.”
The best way to scale a business is to create flywheels, which is another name for a self-reinforcing phenomena. And in the center of any flywheels benefitting any startup are the founders and their team. To make a flywheel happen they must create a network that is mutually reinforcing. The tricky part of any flywheel is overcoming the chicken and egg problem. How does the business generate initial momentum before all the pieces are in place. Usually the jump start takes the form of a free chicken or a free egg.
5. “The answer [to creating a flywheel] lies in two essential variables: the size of the market and the strength of the value proposition. Any growth goes through an exponential curve, then flatters with saturation. If the ceiling of the market opportunity is $200 million, even if you get a flywheel, it will take you from twenty to sixty or seventy, then peter out because you saturated the available space.
The bigger the market the more runway you have—so if you hit that knee of the curve, you can grow exponentially and keep going for a long time. Doubling a business of material size for three to four years leads to a really large, important company. That’s a key element in the flywheel idea.”
To achieve the sort of growth needed by venture capital it is best to be surfing on a phenomenon that is nonlinear. Moore’s law is one such phenomenon especially when the business also benefits from network effects. Sometimes a flywheel is created in a really small markets and that is not so interesting to a venture capitalist given the need for unicorn style returns.
6. “Companies can end up with too much cash. They might have a 15-month runway. They get complacent and there’s not enough critical thinking. Things go bump at 9 months and it turns into a crisis. And then no one wants to invest more.”
Josh Kopelman of First Round Capital has a great post about raising cash in which he said: “You should target 18 to 24 months of runway post Series Seed.” He also makes important notes about how much harder it is to raise an A round than seed stage capital. The amount of Series A capital available is not much bigger and the number of seed funded startups competing for the money is larger than has been the case in the past. One suggested rule is that a startup that has 12 months of cash should be thinking about raising more cash, and should definitely have started raising by the time they have only 9 months of cash, and should be nervous if they only have six months of cash on hand.
7. To achieve a big success, many things must come together. In some cases, what looked like smooth sailing from the outside was more like a near death experience; a few small changes and the outcome would have been dramatically different. There is always a mixture of skill and luck involved.”
“You have to put yourself in a position to be lucky.”
When considering the difference between luck and skill is it always best to refer to the work of Michael Mauboussin: “There’s a quick and easy way to test whether an activity involves skill; ask whether you can lose on purpose. In games of skill, it’s clear that you can lose intentionally but when playing roulette or the lottery you can’t lose on purpose.” My friend Craig McCaw said to me more than once that a ship as viewed from the dock may look pretty with the captain smiling from the upper deck in a resplendent uniform — but under the decks there is inevitably some ugliness associated with the travails of actually running something.
8. “Problem companies can actually take up more of your time than the successful ones.”
Time is the scarcest resource of a founder or venture capitalist. And the biggest time sink is a business that has lots of problems. When problems arise, that is when the value of a great board, advisers and mentors kicks in and the reason why when given a choice a startup always wants to raise more than money. Investors who bring expertise and helpful relationships to the business are always preferable to purely financial investors.
9. “It’s important to choose initial investors who are not twitchy and rushing for an exit.”
“Who are you getting in business with? You really have to get to know the [VCs] you might be working with. You’re essentially entering a long-term relationship.”
“Consider a simple 2 x 2 matrix: on one axis you have easy to get along with founder, and not. On the other, you have exceptional founder, and not. It’s easy to figure out which quadrant VCs make money backing.”
When you are potentially entering into a relationship with people who will be in your life for many years, why would you make a choice to involve people in your business who are hard to get along with? Not only do poor relationships with key people substantially lower your chance of success, the process will make you miserable. Why be miserable? Life is short.
10. “Think about private investing. It’s very different from hedge-fund investing or public investing; you can take advantage of market psychology and short term mismatches because you can exit. We don’t have that luxury in venture capital. We can’t bet this trend will be fashionable for the next three years. By definition we need to have a long term stance. Maybe the company goes public or is acquired in three years, five years, ten years— who knows …We like long runways.”
The length of time it takes for a venture capital investment to pay off drives many aspects of the venture capital industry. Sequoia is rather famous for saying to its portfolio companies: “if you don’t have cash for a long runway, you better have a revenue model that gets you to cash-flow positive quickly.” The better option is to have enough cash and cash flow to last a long time. Warren Buffett treats cash as a call option with no expiration date, an option on every asset class, with no strike price. As an analogy, venture capital funds lock up capital from the limited partners during the life of the fund for that reason. Buffett again says “Cash combined with courage in a crisis is priceless.” It is during a downturn that the hiring gets easier and cheaper, so building a company then can ironically be very attractive.
11. “Since the distribution of startup investment outcomes follows a power law, you cannot simply expect to make money by simply cutting checks. That is, you cannot simply offer a commodity. You have to be able to help portfolio companies in a differentiated way, such as leveraging your network on their behalf or advising them well.”
Every startup and its founders, employees, business and markets are unique. Startups need hands-on help with finding product market fit, recruiting, finance, team building and other aspects of building a business. If the venture capitalists involved in a startup are not assisting with things like recruiting early engineers and closing big sales, the startup has the wrong venture capitalists. Venture capital is a service business, not just a way to make money via finance.
12. “There is a subtle benefit of actuarial science which I didn’t appreciate when I joined the profession. Professor Robert Dorrington at UCT once quipped, ‘Actuaries are trained to think 30 years into the future and accountants are trained to think a year in arrears.’ Part of what actuarial science enforces in you is long-term thinking and that frame of mind influences the work that I do today. We invest in companies that employ three people and we have to imagine what the company might turn out to be in 10 or 15 years.”
Roelof Botha was actually trained as an actuary. He points out that a successful venture capitalist must able to imagine what something might be a 10-15 years later. Of course, since it is magnitude of success and not frequency of success that will determine outcomes, a venture capitalist only needs to be really right about what they imagine in a few cases.
Imagining the future is not a science but an art. This description from Botha about what he is looking for is qualitative: “The key to start-up success is purity of motivation… If they can weave a believable story with a compelling value proposition, they’ll have us hooked.”