This post is a bit of inside baseball, but bear with me.
Like everyone else, I was very impressed by Facebook’s $16B+ acquisition of WhatApp. Apart from the founders and employees of the company, Sequoia Capital was the big winner, and that was recognized by everyone.
As a VC, I was extremely impressed with Sequoia’s investment, just based on the information provided publicly.
Umm… thanks Rob, thanks for stating the obvious. Of course if you invest in a company that exits for $16B and return billions of dollars to investors, that’s very impressive.
But for those outside the VC business, there are a few nuances here that aren’t obvious, but really goes to further illustrate why the team at Sequoia delivers such extraordinary performance over time with a pretty big fund.
The most impressive fact is that Sequoia is the only institutional investor in the company. This is very unusual for most large scale VC-backed companies. Sequoia led an $8M series A round in 2011, 2 years into the life of the company, and put in another $50M over time.
Here’s why this is contrary to how most VC’s act:
- Most VC’s buy their ownership in a company relatively early. They would like to increase it over time in their winners, but they also like getting external validation that they have made a good investment by getting another firm to mark-up their investment. Basically, this means that another VC invests at a higher valuation, making the early VC seem really smart and able to show unrealized gains. This tends to make LPs happy and make the lead partner look good among his or her colleagues.
- Most VC’s like having some leverage on their dollars. They like to share risk with other investors in case things go sideways. It’s comforting to be able to maintain ownership by putting in $X, while someone else provides capital to the company by putting in $5X. It’s also nice to have some other deep pockets beside you in case things go wrong, or markets turn sour.
But this is actually not what you want to do. As an investor, you want to put as much money into your winners as possible. External impression or leverage be damned. When a company is ultimately successful, every VC thinks to themselves “man, we should have just invested more earlier”. But few firms actually do this. It’s hard, and takes a LOT of guts. Some folks on Twitter commented that Sequoia is a big fund, thus, this is easier for them. Sequoia is pretty big, but there are other VC funds that are of similar size, and I don’t see this behavior most of the time. Also, $60M in capital is not chump change. This financing probably came out the Sequoia US Venture fund and Growth fund, which are separate entities, but I believe represent a pool of capital somewhere in the neighborhood of $1.2B. So $58M is still nearly 5% of their total fund in one company. If a fund was $300M, that would be $13-$15M into a single company with no other coinvestors. You don’t see that very often at all.
I’ve also seen multiple tweets comment that this was an obvious decision because of the traction that WhatsApp had. Again, I think this is easy to say in retrospect, but not so in reality for a few reasons.
- First, messaging apps don’t monetize very well. There are tons of investors who would dismiss the category entirely because it’s hard to build a big business. It’s kind of like chat and instant messenger. Big user bases, but tiny revenues. The userbase is also largely international, as is most of the revenue, another ding on the company’s ability to monetize. Companies like Skype have eventually monetized, but through premium services associated with long distance calls, which doesn’t quite seem like a great direction for the company and is ultimately a commodity game.
- Second, not all companies with “user traction” are valuable. We tend to remember the winners. But the battlefield is littered with the decaying carcasses of the losers. Some companies are the early entrants and seem like great winners, but no one snatches them up and they fail to build a real business and durable service (MySpace). Others grow really quickly out of the gates and fade just as quickly (I could name a bunch of examples, but I don’t want to hurt people’s feelings). Also, because of the first point, getting a really big exit is probably dependent on acquisition, and once you get beyond a certain scale, your list of acquirers is pretty darn slim.
- Third, investing in traction is obvious, but at what price is not so obvious. Sequoia essentially paid a very high price for Whatsapp equity with little or no external market validators. How high? Last Friday, it was reported that the valuation for WhatsApp at the series A was $80M, and the subsequent $50 was invested at a value of $1.5B in mid 2013. This was higher than even my own back of the envelope math (I had previously estimated that the last round was done at ~$800M). If this is true, and we believe that the company was on a path towards $20M in revenue last year, that’s a 75X+ revenue multiple. Insanely high, even in the frothy environment we find ourselves in at the present time.
- Fourth, regardless of what Sequoia wanted to do, the ultimate decision around a financing is up to the entrepreneurs. Techcrunch’s friday report mentioned that the last round’s financing was done with 3X participation. This means that in a downside scenario, Sequoia would get paid out 3x $50M first, before anyone else, including founders and employees. This isn’t a crazy term given the valuation, but given the traction, there would likely be other potential buyers at that price, and maybe without that kind of preference. But the founders chose to let Sequoia speak for the entire round, even though one could come up with a dozen reasons why it might be beneficial for the founders to diversify their investor base. To name just a few: 1) expand the rolodex of connections 2) expand the capital sources in case things go sideways and more money is needed 3) bring another set of intellectual capital to the table with different experiences, especially with social/consumer internet experience from some of the recent winners (Facebook, Twitter, etc). 4) create an auction for the financing and drive up the price even higher, etc. etc. But ultimately, the founders did not take this path, and chose Sequoia for the entire round. This indicates that the relationship between the founders and the investors was very strong and that there really wasn’t anything lacking that would lead the founders to seek out other capital partners. Again, pretty unusual for a company at that stage.
There are a lot of other things to admire about Whatsapp and Sequoia. But hopefully this gives a bit of color on one element that I find really impressive and isn’t that obvious unless you are in the VC industry yourself. I can almost guarantee that if any other fund was an investor in this company, the cap table would look very different by the time they exited. Well done.
Note: I am basing my observations and analysis entirely off of public information, and have had no substantive conversations with anyone at Sequoia or Whatsapp about the company and this investment.
Since I posted my Seed VC Decision Tree, one of the most frequent requests I’ve gotten is to define what makes an “awesome founder”. I’ve hesitated to define this because I think evaluating founders is very subjective and I hate to make anyone think I have a particular checklist or profile of founder that I’m looking for. Since starting NextView, I’ve worked with founders of a wide variety of backgrounds, experience, and attributes. Many of these founders share some common characteristics, but if you put them all in the room, I think you’d be surprised at their differences as well.
But, I try to respond to my readers as best as I can, so here’s my best attempt. I think there are many dozens of attributes that awesome founders have, but here are the four that I find to be nearly universal:
1. Smart and Tough. It’s just a baseline requirement. Starting and leading a company is not easy work. Not all awesome founders are necessarily genius-level smart. Nor are all founders UFC-level tough. But there is a baseline that is certainly well above the top 5% of humans on both. No need to say much more.
2. Convincing. Founders need to all have their own way to be convincing. It doesn’t look the same for everyone, but as a CEO, you need to convince people all the time. You need to convince customers to use a product before they really should. You need to convince partners to work with a no-name company at the risk of their jobs and reputation. You need to convince employees to work their ass off for a lot less pay than they are probably used to. You need to convince candidates to join a company that may go nowhere fast. And you need to convince investors to ascribe value to things have haven’t happened yet. Not all founders are evangelistic, charismatic, or the greatest salespeople. But almost all are able to be very convincing in their own way.
3. Superlative. I’ve found that awesome founders tend to be really really great at something. No one can be amazing at everything, but I’ve seen the most success with founders that show superlative traits. I’m always excited when I hear the word “best” in reference calls. A lot of people are “very strong” or “great to work with”. But quite often, when I am referencing founders we ultimately invest in, I hear the person who is providing the reference almost correct me and say something like “he’s not just good…”. This goes for folks with a ton of experience and functional expertise as well as those that are relatively raw or have no prior startup experience. I remember doing a reference call on Stu Wall, the founder and CEO of Signpost many years ago. Stu had no startup experience, and at that point had only been a junior consultant at Bain previously. But I asked one of his former managers how he stacked up relative to the other associates she had worked with – top 5%? Top 10%? “Oh no” she said “Stu is clearly the best”.
4. Fitting for the task at hand. Every company is different. All around athletes are fine, but usually, great founders tend to be tuned well to the task at hand. This doesn’t necessarily mean domain experience. It does mean a strong overlap between the skills and attributes of the founder with the short-medium term needs of the company she is trying to build. It doesn’t do much to have a strong, technical founder at the helm of a company where technology is not a differentiator. It also doesn’t help to have an experienced, Fortune 500 exec at the helm of a company that is all about building a great consumer-social product experience. Many founders have multiple strong attributes, but great founders are great in the context of the task at hand.
I first met Matt Lauzon about 6 years ago when he was raising capital for his first company Gemvara. Although I wasn’t involved with Gemvara as an investor, I was a huge fan of Matt, and we developed a relationship over the years that I really enjoyed (and hopefully I added some value along the way). To see a younger version of Matt where he talks about starting his first company and the people that supported him along the way, check out this interview we did back in 2011.
One of Matt’s extraordinary traits is his ability to recruit, motivate, and lead teams in a way that can’t really be taught. Matt has been able to do this very effectively with folks of his generation or younger who might be individual contributors, as well as extremely seasoned executives who are way more experienced than he is. In many ways, Matt’s new company, Dunwello, seeks to bottle the practices that he (and other great managers) see as highly effective at motivating people at work and bringing out the very best in teams and organizations. The initial product is still in stealth (although it has been tested quietly and there are over a hundred companies on the wait list), and we are all excited about Dunwello’s potential to realize Matt’s over-arching belief that “every person at every company should be both happy and productive.”
Joining Matt Lauzon on this endeavor is Matt Brand, a terrific technical entrepreneur who was previously a part of the team at Tabblo that was acquired by HP. You’ll hear more about the company in the coming months, but until then, if you lead a team and care about bringing out their best potential, sign up for the waiting list here. Also, the company is looking for talented, hungry developers and product designers. Check that out here.
I’m co-hosting an event in 2 weeks with an old friend and colleague of mine from Silicon Valley named Adam Nash. Adam is currently the CEO of Wealthfront, the world’s fastest growing online financial advisor. Previously, Adam was VP of Product at LinkedIN and an EIR at Greylock. Adam and I met 11 years ago when we were both at ebay, so it’s a nice coincidence that ebay/Paypal Boston is also our hosts for the event.
Adam has spoken about growth and virality on numerous occasions, but this is the first time he’s speaking on the topic in Boston. He also has penned some of THE BEST blog posts on the topic that I refer folks to on a weekly basis. I’m really excited to have him share some of his experiences with the Boston Community, and there will also be a couple local guest speakers joining in as well.
Details below. Seating is limited, so Please RSVP to save your spot and so we can provide enough refreshments (beer) and so we don’t drive the building security crazy.
Event: Growth Lessons from Silicon Valley
Location: Paypal Boston – 1 International Place, 5th Floor
Special thanks to Paypal for generously hosting our event and for Venturefizz for helping us provide refreshments.
At least a few times a week, I get asked “are we too early to be raising money” by an entrepreneur. This might be in the context of a company trying to raise their seed round, or a company that is further along that I’m giving feedback to about a series A, B, or C round. Another related question I often get is “what do I need to accomplish to raise money from investor X?”
There are some rubrics that arise from time to time about what it takes to be “ready” to raise a round. For example, there is sort of a magic number for SaaS businesses to achieve $100K MRR, which is usually a good benchmark for being able to raise a decent VC-led series A or B. But overall, I think that this is a question that is very difficult to answer. No matter where you draw the line in the sand, there are cases of companies that have raised capital way earlier with way less meat on the bones. And at the same time, there will be companies that had way more meat on the bones, but struggled to raise.
Here’s my framework for how I (and I think many investors) think about how ready a company is to be funded. Think of this as sort of a sequel to my seed VC decision tree:
So, here’s what’s going on. As an investor, I am thinking about every opportunity in terms of my conviction around the team, product approach, and market opportunity. The final factor is usually deal terms and pricing, but usually, that gets figured out last. I’m smashing that all into some measure of “conviction” on the vertical axis.
At the same time, for any given company, there is a “burden of proof” that is required to get an investor to the point that they will want to invest. These are all the proof points that the business is working, and can range from actual financial metrics to even subjective things like how industry experts and potential customers are perceiving the idea.
The kinks in the curve show the major milestones for most business. The first kink is going from product-discovery to real product/market fit. The reason it’s a sharp kink is that when you clear that threshold of “proof”, the conviction needed for investors to get interested drops significantly. The same happens when you go from product/market fit to having an established, repeatable, business model and growth machine. This is the second kink in the curve.
This over-simplifies things of course, but generally speaking, seed rounds happen before product/market fit, series A’s (and some B’s) happen between PMF and figuring out the business/growth machine, and C’s and later happen after the machine is built.
The sad faces are any place under the curve, which basically represents when investors will say “no”. A “no” happens because the burden of proof for the company is too high given the investor’s conviction. You will notice that between the kinks, the curve is relatively flat. This illustrates the reality that when investors lack conviction, the “proof” they need to eventually say “yes” is usually unreasonable. To put it another way, an investor that has just a little less conviction than one who would be willing to say “yes” has a much higher burden of proof.
This is why sometimes entrepreneurs feel like “keeping investors up to date” just results in the goal posts being moved back more and more each time. This is also why entrepreneurs are almost always kind of puzzled and disappointed when they ask an investor “what would we need to accomplish to get you interested”?
VC’s pretty much live in the unhappy area under the curve. We consider thousands of potential investments each year, and the conclusion almost all the time is that our conviction around the opportunity relative to the proof don’t jive. Even for companies that are far along, the valuation is the great equalizer. An investor may love the team, product, and market, and be impressed by the proof points, but think that it’s just not a reasonable risk/return at a particular price.
If you assume that the startup market is approaching efficiency (which is increasingly less debatable) then the pricing of a deal should get bid up to a point that is essentially too expensive except for the investor with the most conviction. Another way to think about this is from a quote from Mark Zuckerberg at the time when Facebook was approached by Yahoo to be acquired for $1B. When discussing board conversation about turning down the offer, Peter Thiel described Zuckerberg’s argument in this way:
“[Yahoo] had no definitive idea about the future. They did not properly value things that did not yet exist so they were therefore undervaluing the business.”
In a way, VC’s that actually pull the trigger on an investment are thinking in this way almost every time they do a deal. They are committing to a future that is undefined, at a stage that most others think is too early, at a price that most others think is too high. This is also why we always remind founders that fundraising is about “searching for true believers, not convincing skeptics.” Skeptics are further down the conviction axis, and because of the slope of the curve, the burden of proof to get them over the hump is just impractical.
Note: This is not true for what some VC’s call “proprietary deals”. The idea here is that some entrepreneurs will work with a VC at a price that many VC’s would love to invest, but because of a pre-existing relationship, that VC gets to win the deal at below market price. This does happen, but realistically, I think is less than 20% of deals that are done.