Don Valentine, Sequoia Capital: "Target Big Markets"

0:16 please join me today in giving a GSB welcome to Don Valentine I didn't realize that were this many people had no place to go at noon I want to thank all the women in the room for

0:49 Zappos this is the only company that we've ever done where the product was priced inversely proportional to the amount of material that made the shoe so if you ever hear any lady you're interested in or involved with talk about shoe prices the number of pairs of shoes they have it is

1:21 amazing and and you can Wonder after that introduction what we were doing investing in primarily lady shoes fortunately I say totally factiously fortunately Amazon bought zapo for from us about four months ago and I say they bought it because we were not selling it and if you can believe it we had a big argument at sequa whether we wanted to sell it for a billion

1:54 three once we established which currency we were talking about the argument was short you might ask or wonder who these people are and you might recognize some of them but there's one interesting Distinction on this slide as far as I can remember very few of them went to the Stanford Business

2:27 School there are two very distinguished guys on this slide Jerry Yang is at the top of the slide and the reason I point him out first is that he did a building with the proceeds of his Yahoo success and the man right below him Jensen hang also did a building which is opening today so today is a big day to

3:00 celebrate the results of some of these characters that you see before you they were selected randomly as were the companies it's always nice when you can make the slide that shows the success and apply your selective memory to those other companies that didn't make this slide but let me Begin by talking about

3:30 a question that's often asked I do a lot of the interviewing and recruiting of people joining sequa and one of the subjects I asked them about is who's got the water I asked them about is why do you want to join Sequoia assuming you think we're successful why do you think we're successful what have you

4:04 learned and it turns out that many or most of the people in The Venture business historically would answer that question by telling you they finance the best and brightest the greatest managers and all that stuff we do not which maybe is why you don't recognize a lot of the people in the picture we have always FOC focus on the market the size of the market the

4:34 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 so we don't spend a lot of time with wondering about where people went to school how smart they are and all the

5:05 rest of that we're interested in their idea about the market thereafter the magnitude of the problem they're solving and what can happen if in fact the combination of sea and the individuals are correct so if you just think of the picture where Jerry is profiled at the top what were we

5:37 thinking when we financed Yahoo or maybe more accurately the picture in the in the upper left hand side for you the two founders of Apple what did they have in mind they had in mind the idea of you all having your own computer computer the opportunity to have your own computer then was a deck 100 computer a mini computer that cost

6:10 $250,000 now I know the tuition is high here but I don't think a lot of you come here with deck 100s simply because there was no way to visualize a world in which the the computer was ever going to be cost reduced from the price that deck had it at to the computer prices that you face

6:40 now and using apple as an example one of the sub questions that I was encouraged to talk about is how do you go about picking choosing we don't choose people we choose markets and once we choose a market there's a primary product and we rarely ever invest in an area where there's only one

7:12 product so if you take apple none of you are old enough to remember that the original system governing memory was an audio tap layer now you have to really have a great sense of humor using an audio tape player as a primary memory they were highly unreliable and they took forever to

7:44 download the information so we knew if you think of the Apple computer as a system we knew we had to finance one or more memory companies disk dri companies we had to have initially floppy discs with needed financing disc drives that made the memory information

8:15 portable unfortunately for us IBM had always had a facility in San Jose where they located their R&D for memories so this was a very fluid community we helped ourselves to some of the people from IBM Finance several companies in the dis Drive business one of which achieve revenues of a billion dollars without the memory system the PC

8:48 is nothing so if you keep digging away at the system what else do you invest in well Xerox was very generous being an East Coast company and I have a slide that I'll save a little bit that features my vision of Xerox Xerox had a place called Xerox

9:21 Park and when the Apple people went to Xerox Park that they found a few things that they needed they found a mouse so we financed all of these things that we found at Xerox Park they had the best guey on the west coast Apple has always been famous for having a superior graphic

9:51 interface thanks to the generosity of Park and their people who are very gracious at sharing so this is how we chose to invest on a system application Level we looked at the system the Apple computer and in the final analysis made over 15 investments in that

10:21 category and one of the Investments we made was an application investment the guy with the sweater on top started Electronic Arts we started the company in our office and at a point in time when they had more people in our office than Sequoia people we asked them to leave but that's how Electronics art was created and I'll give you another

10:53 illustration of the Six Degrees of Separation concept being applicable but we have always tried to aggregate applications and Technical capabilities in a platform and apple is the example that is probably the most visually prominent right now Steve was not always the best marketing guy guy in the world just

11:25 recently but marketing is one of those things that people underestimate there was a company called Sony that had 90% market share in Mobile Music how many of you had a Walkman how many of you don't have a

11:56 Walkman you have one of Apple's prodct products which if you think about it is a Walkman on steroids Fidelity is better the number of musical choices are better so a lot of products if you miss a generation are phenomenal knockoffs of huge market shares held by companies like

12:30 Sony and I can't resist wrong direction this is my the the dinosaurs are very alert this morning my view of the board of a big company

13:01 Xerox was in Rochester they opened Xerox Park and they conducted a technological picnic for a number of years where the companies in Silicon Valley ate lavishly at the picnic given by Xerox Sony was very gracious at donating a product and as far as I know they haven't struck back with any attempt to deal with Apple that took their entire Market

13:32 why does that happen well a lot of the boards are developed and built around the end ofal thinkers and they don't get any better Xerox one of my favorite tragedies was a spectacular company in Rochester New York had all the patents had market share huge profits cash flow that was a dream and they were persuaded by some people in Wall

14:02 Street to move from Rochester to Southern Connecticut and to change the nature of the company and become a service company so they became an insurance company they became a Wall Street Brokerage kind of company and they left all of the right people in Rochester where all the patents were and everything and when that move was made to Connecticut I have to to believe that somewhere in Tokyo Rico and Samsung and everybody

14:35 else who were planning on taking their market share away applauded the fact that Xerox was abandoning their strength and going in a direction that made no sense you have to select a board like that to do that so we've established the fact that that in our case the market is everything and to us we have gone into

15:06 business with some people who had absolutely no business credentials and we organized the companies in ways so that the people who are going to run them who are often younger than you are could run them BAS based on the limited experience they had so we we taught them Outsourcing we tried to explain to them

15:39 that making everything in housee might have worked for Sloan and the Ford family but certainly not recently we tried to teach them that you only had to do a couple of things well in our companies you had to be very good at Technology and Engineering and that normally took us about six people to start the

16:10 company the second functional skill we were always interested in establishing was marketing so that we could tell what the Dynamics of the market were with our checkbook at sequ we were not interested in creating markets it's too expensive we were interested in exploiting markets early so that when we were with the right set of

16:43 people wait a minute we didn't want that these are the the right people technologists people who had a dream of some way to solve a problem most of them were not interested in becoming wealthy that was an accident they were interested in solving technology problems and creating new products and many of them have done it

17:15 brilliantly and that is the sort of Cornerstone history from our perspective about how and why we start com companes how we choose less the people and more the market because people from our point of view are readily available and this has been a hotbed of training grounds so every time

17:48 a company succeeds here every time 1969 came around and Intel started and a couple years later they had all of of their momentum started you had a whole bunch of people management and training so we have been very generous at circulating people throughout the community there are a couple of organizations that have been repositories of

18:19 Technology SRI is is one of the historic ones I've already mentioned Xerox there's one that you wouldn't ever have heard of called The Wagon Wheel and what was the fourth one IBM these companies were incredibly critical to the formation of most of the

18:51 great companies in Silicon Valley was they made a component part of a system which in our case if you were investing in systems and applications that solve big problems now why did Cisco come out of the block screaming their it Department was where the product was developed interestingly and the problem was PCS had now populated the remote

19:24 offices in big companies and the information packets coming from the East to the West that light speed had a hard time finding the right Mainframe so you had a condition called broadcast storms there were collisions of these packets all over the place Cisco's solution was to design a product called

19:55 a router which merely a identified something coming at light speed and directing it to the right end location initially they did this from a private home in Atherton until the aeton police found out and they sold them to all of the other it departments and all of the

20:27 other universities with their first approach the customers but here is an illustration of a product that was derivative of a number of our other experiences that led us to hear about the packet problem the broadcast storm problem so finding people who knew something about that was a matter of search and we have always had a search function looking for the people that we want to populate our companies

20:59 with unlike other people in the Venture business we don't wait for you to knock on our door we knock on your door we know generally speaking in a lot of respects which kinds of companies which kinds of products and therefore which kinds of people so the people to us become very important for their fundamental technical skills when applied to a particular a problem that we're interested in

21:31 solving a different approach than many people in the Venture business have followed I don't suggest that it's the only approach and I certainly don't want to leave you with the impression that it always works we have some companies that are beyond the concept of hideous and failures hard to believe I understand but

22:02 so one of the things I meant to mention earlier is that when we talk about questions I have a rule about questions I don't answer any questions that are more than 20 words I'm not interested in you're making a speech but if you have a question figure out how to express it in less than 20 words now I'll tell you about a real

22:35 experience because one of the things that's true in my world The Art of Storytelling is incredibly important and many and maybe even most of the entrepreneurs who come to talk to us can't tell the story so one day there were three entrepreneurs and by accident there were three people from

23:07 sequa and this guy started at the atom and was ranting about how they were going to change the world with this product after 20 minutes I just decided that we're not going anywhere his other two Founders were frustrated so I asked him for one of his calling cards he gave it to me and I said we're going to take a

23:37 timeout and during this five minute timeout you're going to write your business plan on the back of your business card and then we'll come back and have you start over and those are the only words you get to explain the ones that are on the back of your business card now it it was more humorous than not this man turns out could write in micr

24:11 code I thought I had done something clever to help him so he must have had 500 words on the back of his calling card and his calling card was the same size as everybody else's learning to tell a story is critically important because that's how the money works the money flows as a function of the stories and one of the critical things I would encourage you to

24:42 learn that's way more important important in my world than anything else is how to ask a question because you want to have the person comfortably telling you what he thinks is important so that you get it now for a long time we don't understand the product or the market while we're listening so we have learned

25:14 to string questions in a way that provides the entrepreneur with a way to explain what he wants to do how long it's going to take who the competition is how much money he needs without feeling threatening for many of the Investments we've made we didn't understand the answers but we constantly work on

25:44 developing the questions and when we have had a company that's failed we always have post-mortems at seoa because we're trying to understand what we missed what question didn't we ask what answer did we not understand because we're dealing with amateur storytellers and it's important that they comfortably can tell you

26:15 what's relevant and despite our audience which is made up of almost exclusively technology people and people who have been founders of companies questions think about questions which is why I have this 20w maximum I normally have 15 but I'm giving you a little latitude here one of the questions that's often asked us is

26:47 where the people who populate Sequoia come from and the answer is pretty Broad ly geographically here we're less interested in their education than we are interested in what they did in their prior companies so the man who joined us this

27:18 week I brought his resume just to highlight for you his name is Alfred Lynn Alfred is not in the picture an accident we financed Alfred's first company which was eventually acquired by Microsoft in I believe 1996 small company internet

27:52 company before we really develop the momentum IBM came and bought it we were not trying to sell it Alfred was the Chief Financial Officer Alfred's second company which we financed in 2004 was zapo he was the chairman he was the chief operating officer and one of the

28:24 people who admitted to knowing absolutely nothing of about women's shoes so we started a company which we sold to Amazon their revenues when we sold the company were about $750 million a year all the shoes were sold over the net there were no bricks in Mortar there were two enormous inventory locations

28:55 one in Las Vegas and one one in the name of the city I've forgotten where Federal Express has all airplanes someplace in Tennessee where is it why did we put the inventory in those places because we committed basically to 24-hour delivery and that's where the planes were and Alfred had figured out a few things about how to be in the retail

29:26 business it wasn't totally a sexist company there were about 10 or 15% of the shoes sold were for men how many of you here have ordered shoes on Yahoo excuse me on did you know Yahoo sold shoes just testing Alfred as is true with a number of

29:59 people over time is one of those people who will work within sequa as well as start companies outside sequa we'll use him as we have used people like him in a multi-tasking way wherever he feels there a company he's specially interested in and some people really like to do

30:29 that and they're good good at it and Alfred happens to be one of those so right now Alfred is at sea but we're all looking forward to what comes next what company is Alfred going to take us to which business will he take us to because the first two businesses were entirely different from one another so he's a clever versatile

31:00 person who knows what he doesn't know think about that because the entrepreneurs that we Finance often times are clueless about what they don't know and what we try to do is supplement through our Rolodex and through the people at sequa we try to supplement what they don't know so we try to make the job of starting the company and the management of the

31:32 company as easy as possible we don't do functions inhouse that we can Outsource so the last person we hire in the management team is the financial officer why do we need him we don't have any money the founders are spending it as fast as they can they developing the product which always is to be generous a little

32:04 late it always cost more money than the founders said but we knew that we finance a lot of companies and the results are always the same so we try to make the management job extremely easy don't manage any function that you can hire someone else so we have people who act as CFOs for our little companies and they may do two

32:34 or three of these companies at a time and there's only one metric that matters in finance in our world and it's cash flow so we hire people that are Wizards at cash flow we don't have balance sheets we love recessions best time to invest in our experience for a lot of reasons but

33:07 recessions don't hurt us nobody is buying we're in product development usually Banks don't lend they don't lend to us ever so it's not unusual so we look forward to recessions and the environment that are in recession now I didn't tell you early on because I don't believe in giving you all of the surprises in the

33:38 front I had a special Advantage going into the Venture business and I think no one else of my relative contemporaries had that advantage and I know this is one that might take an aspirin and a slug of water to deal with but I knew the future and if you don't think knowing the future is a great Advantage it is a phenomenal

34:10 Advantage I spent 10 or 12 years in the semiconductor business all of the products that are here operate on microprocessor I came from the world where they invest vented the microprocessor the guy I work for Bob noise name is on the patent for the microprocessor and we spent huge amounts of time trying to figure out which applications we should attack in which

34:44 order so knowing the Future made it easy for us to very early on invest in a company like Atari we invested in Atari in the early 7s microprocessors were in production Intel started in ' 69 they went into the game business coin operated games as well as home games all microprocessor

35:16 driven Apple almost every significant company we were involved with we understood what it is they were going to use where to get it how much to pay for it and it was relatively easy to aim the entrepreneurs at things that were silicon intensive because that was the technological future people have asked why haven't we

35:49 invested outside of Northern California and the answer I always gave was if we were in a plane flying East we were leaving more opportunities on the ground in Mountain View than we would ever find in any eastern city so I would ask you to think about any place in North America where Venture Capital has

36:19 worked any place in Western Europe with 350 or 400 million people where it's worked it basically has worked in Northern California and my definition of work is look at The Monuments some of your biggest biotech companies were started here and it wasn't called Silicon Valley for nothing so

36:52 this was a an opinion that we held strongly that we didn't have to go anywhere else and I used to sort of tease our limited partners about why we didn't finance companies in choose a state and I told them that I thought the reason would stretch their credibility but that the Catholic church

37:23 was wrong the world is is flat and once you go past Denver you go off the edge into a technological Oblivion who would volunteer the name of a city or an area where venga Capital Works my definition success has to breed

37:55 big monuments it's not Boston and you'd look at Boston youd look at the bay area and think God their schools are at least as good as ours why doesn't it work we have had visitors from around the world the latest one was unbelievable the state department brought the Prime Minister of

38:25 Armenia and out of curiosity we agreed to see them after scurrying around and finding a map and finding Armenia and it's unbelievably far east of the Mississippi and the state department brought these people in and we had guards I mean the the Armenian guys had 10 or 12 of their own

38:56 guys the state State Department brought in and seven or eight others and I I said You know guys we don't have a conference room with that many chairs some of you can come you have to stay outside so we talked with interpreters and they always have a gift so they gave me this gift one of those coffee table books and I looked at it quickly and the Prime

39:26 Minister said not to worry it's in two languages the second language was Russian so I have this book in case any of you are doing research on Armenia I have the book so I'm going to segue in a slightly different direction and I'm going to test you by asking one of you to ask a question 20 words or less or I'll kill

39:57 you there's a brave man here in the front we have a microphone coming your way what did you learn your from your worst investment 10 words is there anybody here from Armenia I mean I need an interpreter I didn't get the question what did you learn from

40:28 your worst investment what did I learn from our worst investment we have invested in a lot of companies and this is not a statistical business so we've had a lot of failures failur is somewhat of a definition dependent issue but we learned that we have never made a bad investment where the technology didn't

41:00 work it didn't work when they said it was going to work they spent more money doing it but what didn't work was the Dynamics of the market we have we have developed some pretty spectacular things for which there were no buyers now were there buyers eventually yeah but the critical thing is getting a product developed where the

41:31 timing of the product's availability and the market demand are simultaneous otherwise you're spending lots of money on developing a market which you did not intend to spend money on and invariably we tend to shut those Investments down now to some of you that may sound

42:01 harsh and to some of the founders of those companies it certainly did sound harsh when we said we're not going to finance you anymore because no one wants the product and we just don't see any prospects which gets me to answer the question where do we get the money from we decided in the beginning that we wanted to have all tax exempt

42:33 sources so we could avoid difficulties with liquidity and selling things in order to make a distribution to pay someone's taxes so our limited partners over roughly 40 years have been tax exempt we have as examples most of your universities wherever you went because we have probably 50 different universities we have a large number of

43:06 us foundations we have a reasonable number of international primarily Western European limited partners so the money comes to us from sources like that which we aggregate in Partnerships it takes us in a $500 million partnership it takes us roughly three or three and a

43:38 half years to invest that money and investing that money includes the amount we reserve for future rounds of financing we never Finance anybody totally on day one we Finance them there're are Milestones depending on how well they do meeting the milestones we then refinance them and it's all done very critically and if in fact the return

44:12 expectation that we started with is no longer reality we often times shut the company down now keep in mind we're financing companies that have 10 people many of these financings are done in our office so they have a lot of free rent free lunches free a lot of things but if they don't get it they don't get any

44:42 more money and yes it's it's necessary to make these kinds of decisions so I think the announcement was that we Finance 500 companies it wouldn't surprise me if we hadn't shut down a 100 of that 500 over the years because the expectations for Success were no longer

45:17 realistic are you just airing out your armpit or you want ask a question I think you need a microphone or at least stand up so everybody can hear you actually I'll pass it back to him let me complete my question I'll hand it to you excuse me sorry sorry man sky entrepreneurism is all about aggression yeah don't worry he's aggressive the question I had not part of it the famous or inFAMOUS rest in peace presentation you published if you

45:47 published it today what would change and why I'm not sure many or most of you heard the question early on in this particular recession a lot of our presidents were asking what to do about spending what to do about hiring so we decided to have a

46:19 meeting a very private meeting in a local place that we never have meetings in to talk about this openly and positively we wrote a paper and you have to understand with slides like mine there's a lot of people at seoa with a a ghoulish sense of humor so the front

46:54 page had a tombstone and it said r i P those of you who are not currently fluent in Latin this was a secret only people invited there were Management in our companies no publicity two days later I saw the paper on CNBC I'm wondering if we were trying to

47:24 get a paper on CNBC we' never succeed seed the answer to the question what impact well it had a lot of impact on our presidents and management because we were interactively discussing what the alternative ways to operate the different companies were in this kind of a recessionary environment these are companies that don't have very much in the way of CAS

47:56 cash and not a lot in the way of borrowing ability well this paper apparently people that I know on the East Coast called me and they said you've scared everybody to death and I said I don't know how or why we were just trying to scare 70 people to death and you were not on the list

48:27 amazing the internet has a lot of great features not all of which are positive and there was an example of what we were doing very privately being publicized worldwide because we had limited partners in Europe contact us and wanted to have a conversation about what we were thinking it wasn't fun what's that new law unintended

49:01 consequences one of the most significant unintended consequences we never have meetings like that with all of 70 presidents where the message is caution keeping the powder dry being thoughtful on expansionary kind of spending ideas and we got more publicity than we ever

49:33 imagined so I wanted to tell another story because there must be people in the audience harboring an opinion or resentment because there's only one woman in this light which for us is pretty good this woman was one of about six founders of

50:04 Cisco and these were the people in Atherton shipping homemade routers to their opposite numbers in the it departments around the country and this woman was one of the core members of management she invented a concept called customer advocacy in her opinion the customers were not well

50:35 cared for as a generalization and she was going to ensure that Cisco was not guilty of paying attention to the customers pretty headyy stuff in a startup well this lady also happened to be smart but tough beyond all comparison and forgiveness was not in her

51:06 vocabulary and when somebody in the management of this embryonic company didn't do it the way she wanted it she shredded them publicly and the president whom I had hired to run Cisco who was the chief executive and it was his right to make the decision he wanted to Terminator and I said you know it's your call but I would encourage you to find a

51:40 way to use this talent because it's an unusual talent and I think it's core to what will differentiate this company so he agreed they had a conversation she took an oath of behavior I wasn't there for that and the next thing I knew about a month later there was seven vice presidents of

52:11 Cisco in my office and their position was very simple either the seven of us stay and Sandy leaves or Sandy stays and the seven of us leave what's your preference So I listened for a while being one of the world's greatest listeners I mean if you're going to laugh laugh but don't

52:47 murmur so I I called the president and I said John you know I I I have a War Ready to be declared in my office here what do you want to do and he said I I can't make it work Sand's got to go so Sandy was separated from the company the company was monumentally successful it went

53:21 public that is her partner in a number of respects both of them left a then public company with 170 million dollar each and she hasn't spoken to me in 15 years I might be lucky there's no telling what you would say so decisions are sometimes made that

53:51 you don't like to see made when a creative force in a company that's doing a lot more good than evil has to go because otherwise you have to build a whole new management team including the president the footnote on the President John morgridge is that he ran the company from basically nothing to

54:22 revenues of a billion five he left because that's all he wanted to do he did an extra 500 million as a favor but he wanted to leave the company at a billion dollars in revenue and and do something different so John was the most like

54:52 me president I have a heart now what does that mean he was the only president iard was cheaper than me he would go to huge length to Stage talks for the management of the company about spending this was a company growing extremely rapidly had gross margins of

55:23 68% was monumentally Cash flow positive they currently generate in free cash on a $40 billion sales base they generate $6 billion dollar a year in excess cash so John's lesson the DNA he created has done the company a lot of

55:54 good where is this you mentioned to me we're overtime they said if I didn't provide you enough opportunity to ask questions I wouldn't get lunch and owing to the fact that I was late going through the Labyrinthian directions I had can we can we do any question

56:32 where is the microphone he has he has custody a lot of responsibility which which markets excite you today and which Market currently in Vogue in the valley gives you the greatest pause or concern answering the question backward the question is about the markets that I like and the markets that I don't like it probably started three or four years

57:03 ago there was a huge you and cry about Nano everybody wanted to do Nano so we were not thrilled about Nano we listened to a lot of people a lot of presentations and turns out in our opinion and bear in mind we have a lot of of semiconductor background and the semiconductor business is a process business it's chemistry and Nano is a process

57:35 business there was no applications that you could easily Point your finger to and say we can do a product in all of those areas and sell it to a lot of different people one of the companies was going to attack the catalytic converter in your car which uses a precious metal and they were going to substitute a less precious

58:06 metal and sell that to the car companies that were still in business and we took a pass on Nano it may have been a mistake it may be that all the great successes in Nano are in front of us but so far I don't see any notches in anybody's rifle as a result of investing successfully in Nano now the positive side of the

58:37 question is what do we like and we continue to like the exploitation of mobile Steve has demonstrated a whole bunch of consumer oriented applications there are lots of other things to be done in the mobile space in our opinion but we don't focus on one

59:11 category to the exclusion of other categories we have teams of people that specialize in different areas of developing a knowledge base and Market sizing information about where we should be spending time and I have established for you that we tend to invest in an application system approach which may be the reason why it didn't work in Nano but it's the reason

59:41 perhaps why it does work in Mobile thank you