Sequoia Capital: Five Questions
Five Questions I'd Ask Founders if I were a Partner at Sequoia Capital
So, today's essay will be a little different than usual. After reviewing my notes on Sequoia Capital, I realized I had more information to share beyond just why they invested in the companies they did. I realized I could recycle some of my notes to produce a new type of essay I intend to start releasing weekly, which will be five questions I’d ask founders if I were a partner at the VC firm of focus for this week.
Since Sequoia was the first firm we explored, this essay will be five questions I’d ask founders if I were a partner of Sequoia. While I don’t know whether they actually ask these questions, I have many direct quotes from current and former partners about what they look for in founders and questions they ask founders when determining whether to invest in a company, so I can extrapolate some reasonable questions.
I think this will be a helpful thought exercise for founders who intend to raise to think about your answers to some of these questions as I believe they are questions an investor would ask whether Sequoia or not, so It’d be good to think about.
For investors, it’s good to think about the questions you like to ask founders and why and read some of these quotes from Sequoia partners, who are certainly some of the best investors in the world, so it’s worth reading this information and maybe adding some of these questions to your list if you think they’re effective.
Let’s get started.
1. Why did you start this company?
I’d ask this question because there must be some type of intense desire to fix the world that you’re sick of for some reason. You’re going to spend at least 10% of your life on this project, working 60+ hour weeks for 10 years. Is your desire to change the world so strong that you’re willing to dedicate such a meaningful portion of it?
Current Sequoia partner and CEO Roelof Botha, has an interesting quote that really gets at why truly dedicated founders start their companies.
“So one of the boards I'm on is a company called Natera. It's a public company in the bioinformatics space. They have the leading technology in the world for doing non-invasive prenatal testing. The founder and I met in high school. He eventually came to Stanford, where he did a PhD in electrical engineering. In 2002, his sister gave birth to a baby that died within a week from a genetic condition that was undetected during her pregnancy.
Matt went back to Stanford to learn everything he could about biology and genetics because he thought that people needed better care. In the 21st century, he found it shocking that we didn't have better technology to help families have healthy children. That was the motivation. Yes, he was a friend of mine, but you hear him talk about the motivation for starting a company like that. It's emotional. And you understand that this person is mission-driven, and then you understand all the things that they did to uncover the nuances of why this is a problem they're going to dedicate maybe the rest of their life to. So I love understanding that eureka moment, that insight.
I'd say the one that probably is most challenging for me is if the founders come across as mercenaries rather than missionaries. If it feels like they're building a business for the sake of building a business or for the sake of getting rich rather than having encountered a problem that they sincerely are passionate about solving, that's the thing that's going to keep them motivated. Because if you're a mercenary, you wilt in the face of adversity.”
I recognize very few founders will be more driven by such an important and personal mission than the founder of Natera. Nonetheless, it’s vital that a founder deeply cares about the mission of their company because, as Roelof says, mercenaries wilt in the face of danger.
If you’re starting a company to make money, then your thinking is flawed because, as a founder, you’re going to make below-market pay for the very slim chance that you hit it big. If you’re qualified to start a company, then you’re likely qualified for a high-paying comfortable job.
Therefore, if the founders are tired of their low pay and aren’t motivated enough in the mission, then they’ll shut the company down, and I, as an investor, lose all my money, so I need to make sure they are motivated by that mission.
Not only is it important to me that the founder is motivated by the mission so that he or she doesn’t quit in the future, but also because the most successful companies are the most value accretive companies for consumers.
Apple gave us computers in our pockets, Google gave us the ability to have any of our questions answered anytime, and Amazon delivers anything we want within two days. There’s a reason these are three of the most valuable companies in the world.
Don’t just take my word for it, Roelof has seen this first hand as he said,
“It's very rare that a company creates or delivers an enormous amount of value and fails to build a good business…”
Additionally, an ultimate focus on solving this problem is required to be successful. There have been unbelievable headwinds from incumbent positioning and regulatory capture that companies like Tesla, Amazon, and Anduril have to go through to build in such a tough environment. They only did this because the entrepreneurs were obsessed with solving these problems. It has to be obsessive.
Former Sequoia partner and CEO Mike Moritz describes the importance of this obsessive trait, saying,
“I think it's a characteristic of the most successful entrepreneurs, which is that they, certainly at the beginning of their company, and often for a very good long time, are able to shut out the rest of the world. And just devote themselves to what they're really interested in doing and shut off all the other distractions because there's really only one thing that they care about. And that care is deep, and it's genuine, and it's the sort of thing that they go to bed, go to sleep thinking about, and they wake up in the morning thinking about.”
Now, I’m not going to ask if a founder goes to sleep thinking about his or her company because I don’t really think that’s fair, but I want to get that impression when the founders are answering why they started the company.
As I said, This is going to be a ten-year journey for the entrepreneurs, which is an extremely long time in our precious and finite lives. I need to make sure the founders are willing to commit to that which can be determined by understanding thoroughly why they started this business and the passion in their delivery to see whether they are a missionary-founder and that all they want to do is see this company succeed.
No amount of money or pressure from incumbents or government regulation is going to stop them. This is why they were put on this earth. That’s the impression I want to get when the founders answer this question.
2. Why can you outmaneuver/disrupt the incumbents?
I want the founders to understand the market they’re going after and why the incumbents won’t squash them. Whether it is the indecision of Incumbents or an inability to innovate due to disrupting themselves, there has to be some type of value prop that would prompt users to pick a new unheard-of company vs. one with decades of mental real estate in the consumer's minds.
We talked about Apple and HP in the Sequoia essay. HP sold $150,000 mainframe computers. They don’t want people to buy $3,000 PCs even though it’s better for the consumer, so Apple did it. That’s a great answer to this question and shows there is an innovator’s dilemma effect in the market. Sequoia founder Don Valentine talks about the importance of these inflection points, saying,
“One of our theories is to seek out opportunities where there is a major change going on. A major dislocation in the way things are done. Wherever there's turmoil, there's indecision, and wherever there's indecision, there's opportunity. When it becomes obvious to anyone who reads Time magazine that it's useful to have a disk drive on a computer, then it's already too late in the cycle to invest in disk drives.”
I love that sentence, “Wherever there’s turmoil, there’s indecision, and wherever there’s indecision, there’s opportunity.” This is something investors love to see a founder recognize. It increases the chances of success because it proves there’s a large market if there are successful companies selling to consumers, but it also shows the incumbents aren’t creating as much value for the consumers as possible.
As I said before, HP was indecisive about whether to disrupt themselves and build personal computers, whereas Apple was coming from zero and had nothing to lose. Jobs and Wozniak recognized that inflection point and eliminated that dislocation of the company providing the most value to its customers it possibly can. Apple filled that void.
Additionally, I need the founder to not only have an insight people see but also realize he or she can leverage new technology to provide a better experience for users in that market.
For example, Uber used iPhones to coordinate rides between drivers and riders that taxi companies weren’t going to build out the infrastructure for. It would be too costly for them because they spent decades building out their own infrastructure and processes. The Taxi Commission of New York isn’t going to give their drivers iPhones and build out algorithms to perfect pick-up times and supply and demand costs.
That’s a perfect why now.
It has to be realistic, though. WebVan didn’t work in the 90s, but Instacart did because while they’re the same business, Instacart could utilize the gig economy when WebVan couldn’t since the app store didn’t exist. Current Sequoia partner Alfred Lin once said something along these lines when he said,
“I think there are specific good reasons for ‘why now’ and there are times when there’s not a good ‘why now.’ In Instacart’s or 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 an on-demand workforce was not available in 1999 because not everybody was carrying a mobile phone. There are certain situations where you have good ‘why nows’ for a particular company to be able to take off.”
So now we’ve covered that the founder recognizes the inflection point in the market where they can utilize new technologies that the incumbents either don’t know how to utilize to improve their processes or can’t because it will be too costly to their core business. That is key for me as an investor to understand early on in the pitch.
But, you not only have to convince me. You have to convince my nana, my mom, my cousin, and everyone else in the world who understands technology much less than you as to why you’re better than the incumbent that they’ve trusted for many years.
They’re the people who are actually going to buy the product, so I need to know you can explain it in a way they’re going to understand. Can you explain that value prop simply?
If not, the idea may not be totally fleshed out, and you might not have a complete understanding of your market, competitors, and why you’ll win. It is common knowledge that the most knowledgeable person in a domain can explain it simply for anyone to understand. If the founder can’t do that, then he or she might not be an expert; a successful founder must be an expert in their domain.
So I not only need you to explain that value prop to me, but in a simple way that anyone listening to you can understand. We can get into the details about how the product works later, but I need to hear that two-sentence pitch that anyone can understand to recognize why your product is better. I heard this from current partner Jim Goetz who said,
“What’s important to us as investors, will be important to the marketplace at large, to your potential partners to potential recruits, and something that candidly very few entrepreneurs get when they walk in the door is: in two to three declarative sentences can you explain to us what's unique, compelling, why you're different, how you're ultimately going to win, and what you're unfair advantage is. ”
So basically, to wrap this all up, I’m looking for a founder who understands the incumbents extremely well because you must be able to articulate how you intend to disrupt them. It won’t be easy, so you have to have that part fleshed out based on technological advancements now or in the future and why the incumbent won’t just copy you.
If the founder can explain that in a clear and concise way that customers and investors would understand well and see why that product or service is so compelling, then that’s a great sign.
3. What is your TAM? How did you come up with that number?
First of all, for those who don’t know, TAM is the total addressable market, so basically, how much consumers spend on products of services in this market total. So Airbnb would use the hospitality market, which would include all money spent on hotels and traditional bed and breakfasts.
So this number can be pretty straightforward since this information can easily be found online.
But, I think it’s a red flag if a company pitches and just says our TAM is $10b because of this McKinsey report and then moves on to the next slide. The market discussion is incredibly important. It tells me, as an investor, that there’s a reasonable path for your business to make at least $100m a year. So, I need you to be operating in multi-billion dollar markets that, ideally, are expanding, or your innovative process utilizing new technologies will cause the market to expand.
So, the market has to be large and growing. That’s the first step. What’s more important is how you intend to capture a significant chunk of that market. I recognized the importance of this when I heard current Sequoia partner Jim Goetz say,
“We regularly see entrepreneurs come in and talk about billion-dollar markets its large TAM's, and that's just not as interesting to us as the passion that comes from trying to solve a very specific pain point for a very specific customer.”
By targeting a specific customer, you can tell a story about your TAM that shows you know who your customers are within that market, how many of them are there, and why they need your service or product.
From that story, you should be able to conclude with how large your TAM is and how you should be able to capture a significant chunk of that market.
Capturing that chunk is hard, though.
What makes obtaining a significant market share easier, though, is when you’re unlocking value for an underserved user. What I mean by that is basically a user that isn’t getting as much value as they could for whatever reason. Current Sequoia partner Jess Less has a great quote on this. She says,
“There are underserved customers everywhere. You have to be a little contrarian to make money in investing. You have to either see opportunities other people don't or opportunities other people underestimate. You have to be willing to take a risk on things that maybe haven't worked before. And I just saw firsthand as a female founder and working on a product targeting women that, hey, there are big businesses out there that people don't think are big businesses, and those underserved customers, if they are served, become wildly, deliriously happy, and then you get that, going back to the community point, a community and this incredible moat of community that leads to word of mouth growth.”
So as I said before, I don’t just want to see a number on a slide that says $10 billion and the entrepreneur to quickly gloss over the size of their market. The WORST thing in the world is to say the classic, “According to this report, our market is $10 billion, so if we just capture 1% of it, we can make $100m dollars a year.”
A six-year-old can do that math.
That tells me nothing about why you can capture 1%. It’s easy to be like, “Oh, 1% isn’t that much; I’m sure we can get that”, but 1% is $100m that random people who have no idea who you have to pay you for.
1% sounds easy, but $100,000,000 sounds a little harder.
So again, I need to hear a compelling story about how you’re utilizing new technology to unlock value for, ideally, an underserved user who may not even know they’re underserved.
The best TAM story in my mind is the one I used for LinkedIn in the Sequoia essay. I wrote something along the lines of:
One of our users, Tom in Florida, used LinkedIn to find ten new hires. He loved the product and shared it with his network of ten other hiring managers who also found ten new hires, loved the product, and told ten other hiring managers about the product.
Therefore, Tom created 100 new users by simply loving the product since it solved his need. Since we believe there are one million Toms in the world, we can get to one hundred million users paying us $100 a year for a $10 billion TAM.
That’s a much better way to describe your TAM. It shows that you know your users, you know they’re underserved, ideally through word-of-mouth growth which shows they really love the product, it shows your product is unlocking new value for them, and it shows why they’re willing to pay for it.
If you don’t have a product in the market or paying customers, then you would have to make your story a hypothetical one, but investors invest in hypothetical outcomes all of the time.
I just have to know that you know the market well enough to explain why there are underserved users and how your product can unlock value for them. Explain that to me in a story from the user's perspective.
4. Why will People Care about this company in 10 years?
The inspiration for this question came from current Sequoia partner Alfred Lin. He said,
“In 10 years, who cares about this company?... The company has to be an important company 10 years from now, so who cares 10 years from now? What does this company become in 10 years?
This is important to understand because, first, simply, I need to know that the founder recognizes this is going to be roughly a ten-year journey. It’s a standard assumption that a startup takes ten years to go from zero to a large exit either through IPO or acquisition.
I need to know that the founder is, first, willing to take that journey.
Second, and more importantly, I need to make sure the founder has planned out what success looks like in ten years. It’s not enough to just have a great idea for a product and go build it. That’s fine for a lifestyle business, but for a venture-backed business that needs to earn at least $100m a year, you have to have a plan on how to hit that number.
Roelof Both shared an exercise he learned from former Treasury Secretary Larry Summers. Roelof said,
“Former Treasury Secretary Larry Summers is on the board with me at Square.. And he posed this as a challenge to the management team at Square.
‘Imagine things go incredibly well over the next three or five years. Actually, write it down. Don’t just think about it, write it down. What does that look like? What does success really look like? What does the company look like? What have you achieved? Which markets do we operate in? Which products have we shipped? Then go write a pre-mortem. Things didn’t go the way you wanted to, what does that look like.”
I really like this framing of defining what success looks like in ten years in every aspect of the company. Product, market, expansion, anything that can happen in a ten-year lifespan of a company, what was achieved?
Additionally, going through why the company fails is just as important. It shows the founders have recognized all of the risks facing the business because if you can recognize the risks, then you can figure out how to mitigate them. It’s the unexpected risks that cause businesses to fail.
So, while I don’t know for sure, having never been in one of these meetings, I think it would make you look really good as a founder if you came into a meeting with two slides that show what success looks like and why, and what failure looks like and why.
It shows you understand your market and have a reasonable path to get to a one-billion-dollar valuation, and it shows you’ve thought about the risks thoroughly. I think that would be a very savvy move and show a lot of maturity.
This last point goes back to the importance of having a vision of success.
To be successful, you have to have a vision of what that looks like. You can’t just stumble your way into success, most of the time, you have to plan for it. You have to clearly visualize what you want to achieve and work towards it.
For any college basketball fans, if you’ve seen the ESPN 30 for 30 film: Survive and Advance, there’s a point where the coach of NC State, Jimmy Valvano, said he visualized cutting down the nets at the national championship every day and made sure his players did too. He wanted everyone to see what success looked like, so it almost became expected that they would reach that point. They knew what it looked like, and coach Valvano was helping them get to that point.
Sequoia founder Don Valentine talks about the importance of a clear vision as he says,
“It's about the building of the idea, the size of the market, the degree of technical risk to get this product finished, who's going to care, and explaining that in a very simple way. We can tell that that person who can do that, explain it in a very simple way, is somebody we want to be in business with…. The only competitive advantage that startups have is focus, speed, and stealth. If you're all over the place, you're not going to be able to execute on those things.”
As I said earlier, a founder has to be a great storyteller to sell customers on the product and investors on the vision. To be a great storyteller, you have to see the future clearly, and to see the future clearly, you have to know everything about your product, market, competitors, and customers.
So I’d ask this question to make sure the founder has planned ahead for his or her company so nothing comes as a major surprise. It shows that they are disciplined enough to recognize it won’t be easy, and this job requires a lot of preparation and realism coupled with extreme optimism.
Founders, manifest that clear vision and be able to explain it in such a way that makes the investors see it as clearly as you do. Venture capitalists are irrational optimists too, so they’re open to dreaming with you. You just have to make that dream compelling enough.
5. What does your first product look like?
I’d ask this question because I want to know how the founder intends to run their company. Is it going to be a lean startup model where you ship out a software product you know isn’t great but want customer feedback to iterate? Or is it going to be the Apple model where you only release beautiful products after years of R&D?
Sequoia partner and former CEO Doug Leonne has a great and funny quote on this. If you haven’t heard him talk, it makes reading this funnier because of his thick New York Italian accent. I highly recommend hearing him speak and then reading this. He says,
“Should you build an imperfect product and get to market early? Sure. Should you build a perfect product that takes longer? Sure. If you look at what Steve Jobs did, everything you put in your hands was not some Rev 1 cheap s***, so there are many ways to have it. There are many ways.
The trick is to understand where you are and break it down to first principles. If I'm selling a hardware product with a cost of goods to millions of people, I probably don't want a very s***** first product.
If I'm selling a simple utility and I need customer feedback, I want to get that out, especially in the consumer marketplace. A piece of software, I want to get that out as quickly as possible, as imperfect as possible, knowing that Rev 1 is the wrong product, but at least we're talking. So don't have a textbook.”
I’d want the entrepreneur to understand this distinction.
As Leone said, there isn’t an absolute wrong answer, but there is a wrong answer if you’re hardware vs. software. I’d want the entrepreneur to be well-versed enough in business strategy that they understand this framing.
Yes, board members can help, but the first product is on the entrepreneur and starts the company. I need to understand that the entrepreneur knows how he or she intends to build the business and the culture, which is defined by the first product.
If it’s a ship and iterate culture, great for software. If it’s a wait-and-perfect culture, great for hardware. This just has to be recognized by the founder and every employee they hire so the company has the right strategy and culture.
Otherwise, you get poor customer responses, spend too much or too little on R&D, and have angry employees. The perfectionist you hired didn’t know you would ship out bad products intentionally to get customer feedback, and the tinkerers didn’t think they’d have to wait three years to ship one product.
It defines the company's culture, shows how you intend to run the business, and that you understand simple business strategy. It’s good for founders to have this part planned out, even before they ship their first product.
6. Bonus Quote
I know I said five questions, but I have one extra quote I wanted to pull that isn’t necessarily a question I could ask but something I’d try to understand while speaking with references.
For those who don’t know, typically a founder gives a pitch, and then the investor asks for a list of references from former employers or co-workers of the entrepreneur to determine who the founder is as a person, and customer references to understand how they feel about the product outside of what the founder has said.
So this quote from Sequoia CEO Roelof Botha describes how Peter Thiel, former CEO of PayPal and Roelof’s former boss at PayPal, leads. Roelof says,
“Peter had an incredible ability to change his mind. Peter would say, “We’re turning left, turning left.” If we weren’t sure, we’d go analyze, and bring him data. We’d show him the results, and he’d say, “Yep, I’ve just looked at it. We’re turning right.” He would just turn like that on a dime, and he had no qualms about this.
I think most people get so stuck in an escalation of commitment where “I need to remain consistent with the person you thought I was yesterday. Otherwise, I’m going to be viewed as irrational.” There’s a whole branch of psychology that talks about this, right? To some extent, people view flip-floppers negatively, especially in politics and things like that. But in business, it’s incredibly valuable if you’re just rational. Peter did that to a T, and it made him an incredible CEO.”
I love this leadership trait. This is exactly what I’d want to hear about the person I’m investing in. Peter Thiel is a genius. Like super genius. He's probably the smartest person in any room he’s in, but he’s still willing to admit when he’s wrong immediately.
He can be gut-driven, as all founders have to be at times, but he isn’t ignorant when data that shows he’s wrong is presented to him. I want to back a founder willing to be vulnerable and admit he or she is wrong, even if it can make that founder look poorly in the short-term, but in the long-term, it’s best for the company.
If all goes well in your company, you will be managing thousands of people. You have to be an exceptional leader, and while these traits can be developed, I want to know that you at least have some inkling of outstanding leadership.
Conclusion:
So those are the five questions I’d ask if I was a partner at Sequoia based on what I’ve read from current and former partners. I hope you liked this essay and learned something from it because I think I’m going to start doing this for every VC firm we cover. I think it’s fun and a good thought exercise for founders and investors.
As always, you can find the podcast version of this essay on SPOTIFY or APPLE PODCASTS. Additionally, all my notes are at allthingsvc.blog if you want to read more. Stay tuned in the next few days for another great essay!
Thanks for reading and have a great rest of your day!