The term unicorn has been re-entering our lexicon recently. In the NBA, people are using the term ‘unicorn’ to talk about players who are 7’ tall like a center, can dribble like a point guard, and can shoot like a shooting guard. Basically, a unicorn in the NBA is a player that defies conventional expectations for a basketball player.
In venture capital, a unicorn is no different in terms of what it means. Unicorn companies are private companies that have a $1B plus valuation; the elite startups that defied the odds, survived the trials and tribulations of early growth, and have become global players. The names of unicorns are well known companies, including Uber, Didi Chuxing, AirBNB, Lyft, WeWork among others. These types of companies are the gold standard for venture capitalists.
Venture Capital Explained
The way venture works is that every so often, a group (think KPCB, Sequoia Capital, or even our own Professor Doyle’s Sigma Prime Ventures among many others) raises what’s called “a funding round.” It consists of investments by pension funds, high net worth individuals, insurance companies, and the ilk, which collectively are called Limited Partners (LP’s), often spearheaded by a single lead investor who can contribute between 30-60% of the total amount. That fund is distributed to members of that group, called ‘General Partners.’ The General Partners are tasked with finding, vetting, and investing in startups in expectation that those companies will exit (whether that’s IPO or acquisition) and earn the firm a good return on that money. As Prof. Doyle talked about last week, venture aims to return 3x the amount of money invested in it at the end of the funding round. Most rounds last 10 years, in order to give time to companies to properly grow and reach valuation targets, so LP’s can only sit and wait as they wait for their return.
This sitting and waiting is what is so hard for LP’s to do. Investments in the stock market can be pulled within a day, bad investments mitigated and damage controlled. VC funds are nothing like that. Once an investment is made in a company, that money is gone. It’s what puts the onus on the GP’s to not only be good investors, future thinking and able to predict market changes or evolutions, but also good board members and advocates for their investments. Their investments must work out, it’s other people’s money after all and it’s other people that can choose to take their money elsewhere for the next fundraising round.
What Does It Mean to Be a Good VC?
So this brings us back to unicorns. The best of the best startups. One unicorn can single handedly change a funding round. For instance, Uber’s valuation today is around $69B, in just June 2014 it was $18.2B, growing by more than 300% in the last 3 years. 10 years ago the company didn’t even exist. That’s the kind of monetary growth achievable by VCs who can spot unicorns and conversely why unicorns are so important to VC firms.
Evaluating Sequoia Capital
So it stands to reason then that measuring VC firms on their unicorn spot and hit rate, while not fully indicative of the quality of the investment firm, is a reasonable place to start evaluations. And no VC firm has done a better job of finding unicorns than Sequoia Capital, who has invested in more unicorns than any other VC firm on earth. Those names are a who’s who in tech: Oracle, Google, and Apple among others. And not only do they get in on the party, they’re often the ones starting it. No one’s invested in more unicorns at Seed/Series A (the first rounds that companies raise) than Sequoia has. Those early investments Sequoia makes at around $1M for a substantial piece of the company can balloon as companies soar past that $1B mark. Those early investment companies are monsters now in their own right: AirBNB, Instacart, and Stripe to name a few.
Who Is Sequoia and How Do They Work?
Sequoia bases their investment strategy on two core pillars: authentic founders and big markets. These pillars are founded on founder Don Valentine’s investment strategy. Boston College’s own Pat Grady gets into these a little more in depth in an awesome podcast I highly recommend here. He explains how teams led by founders who have found authentic problems, problems they themselves have encountered or been stuck at and founded their company to solve, that serve large markets, meaning opportunities that tackled well are worth a lot of money either in terms of number of users in that market or value of services provided in that market, are the teams that Sequoia has seen excel.
Sequoia is structured into two main groups, although there’s overlap between each group by seasoned professionals like Jim Goetz and Michael Moritz, who have experience as VCs taking companies through their full life cycle. One group is called ‘Early’ and, as you might guess, they focus on Seed and Series A companies. The other group is called ‘Growth’ and their focus is on companies that have a substantial number of employees, Pat Grady in the podcast put that number around 150, and experience in a marketplace. Sequoia has both their early stage and growth investing teams tightly integrated in the sense that they have an emphasis on certain types of companies, teams that can define a market for a long period of time, because to Sequoia it doesn’t matter if they interject at the beginning of the company or 12 months away from an IPO because they’re always investing in the same type of company. However, because business decisions are different at seed than at IPO, the teams are split in order to maintain their own investing criteria/due diligence.
One really interesting part of Sequoia is who their LP’s are. They raise their money from nonprofits, universities, and foundations. When they strike out on their funding rounds, it’s kids not getting scholarships and cancer research that misses out. I can’t even number the amount of Sequoia General Partners who listed that on their website profile on why they do what they do.
Not only do they raise money that way, but their company culture treats their teams like partners rather than investments. From their website: “We’re serious about our work, and carefully choose the words to describe it. Terms like “deal” or “exit” are forbidden. And while we’re sometimes called investors, that is not our frame of mind. We consider ourselves partners for the long term.” That’s a VC firm that puts companies first, pushing them to succeed where possible, and setting those companies up for the most success. Not only is the firm stocked with high quality GP’s and filled with an ethos of putting others first, but Sequoia continues to excel in putting their companies first and being a partner on the way to success.
Questions/Things to Think About
- How does a VC know he/she is asking the right questions of a company?
- What market miss, a company that you thought would create a new market that didn’t for some reason, have you made and how do you make sure you learn from that, when every market miss is going to be unique in its own right?
- What is the key to making sure that the Growth and Early teams are on the same page in terms of company/Sequoia fit?