ROELOF BOTHA IS A partner at the venture capital firm Sequoia Capital, where he is responsible for strategy, team composition, and fundraising. Botha grew up in Pretoria and Cape Town, South Africa. Botha started his career working for McKinsey in Johannesburg from August 1996 through June 1998. He then moved to the United States where he completed an MBA at Stanford University. He is also a trained actuary. After serving in a number of roles at PayPal, including CFO, he joined Sequoia in 2003. His portfolio companies have included Instagram, Stripe, Tumblr, and YouTube. Botha believes “it’s very hard to be in venture capital if you haven’t walked in the shoes of a founder or entrepreneur, or been involved in building a company.”
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 growth models, term sheets, and lots of peripheral issues when the business is unable to provide core product value are missing the boat. In making these statements, Botha is expressing a desire for missionary founders over mercenary founders. Brian Chesky of Airbnb once said, “In a war, missionaries outlast and endure mercenaries.”
2. “There is a 50 percent mortality rate for venture-funded businesses. Think about that curve. Half of it goes to zero. Some people try for 3X returns with a very low mortality rate. But even that VC model is still subject to a power law. The curve is just not as steep.”
This fact of life in the venture business means focusing on big markets and businesses with the potential to grow revenues and profits at nonlinear rates. Most companies formed by entrepreneurs are not candidates for venture capital. That’s okay. The best way forward for most businesses is 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 just small businesses that should be looking for what amounts to small-business finance. The businesses and markets created by these entrepreneurs are a key part of building a healthy economy and creating jobs. But they are not the sort of companies suitable for venture investing. Again, that’s okay. The amount of venture financing overall is 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 by venture capitalists is relatively small when put into the context of the overall economy.
4. “Think of yourself as the central point of a network.”
The best way to scale a business quickly is to create flywheels; that is, self-reinforcing phenomena. In the center of the flywheels benefiting a startup are the founders and their team. To get a flywheel going, the founders must create a seed that will jump-start a process that will reinforce itself. The tricky part of setting up 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 “egg.” While sometimes it does not matter which one is free, there is usually an optimal side of the market to become the seed and another that is the source of profit.
5. “The answer to creating a flywheel lies in two essential variables: the size of the market and the strength of the value proposition. Growth goes through an exponential curve, then flattens 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 million, 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 vast company. That’s a fundamental element in the flywheel idea.
To achieve the growth needed by venture capitalists to make their business model work, it is best to be surfing on a nonlinear phenomenon. Moore’s law as broadly considered is one such phenomenon, especially when the business also benefits from network effects. Sometimes a flywheel is created in a small market, and that is not as interesting to a venture capitalist.
6. “Companies can end up with too much cash. They might have a fifteen-month runway. They get complacent and there’s not enough critical thinking. Things go bump at nine months, and it turns into a crisis. And then no one wants to invest more.”
One suggested rule of thumb is that a startup with twelve months of cash should be thinking about raising more cash, should start raising capital by the time they have nine months of cash, and should be nervous if they only have six months of cash on hand. It is much harder to raise a series A round of financing than seed-stage capital. Compared with the past, there is not much more series A capital available today, but there are more seed-funded startups competing for that money.
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.”
When considering the difference between luck and skill, it is always best to refer to the work of Michael Mauboussin who has said, “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 is clear that you can lose intentionally but when playing roulette or the lottery you can’t lose on purpose.” If you can influence the outcome by working harder, that is skill and not luck.
8. “Problem companies can take up more of your time than the successful ones.”
Time is the scarcest resource for a founder or venture capitalist. And the biggest time sink of all is a business with lots of problems. It is when problems arise that the value of a great board of directors, advisers, and mentors kicks in. And it is because of the inevitability of problems that, when given a choice, a startup should always want to raise more than money. Investors who bring hustle, good judgment, expertise, and significant relationships to the business are 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 have to get to know the venture capitalists you might be working with. You’re essentially entering a long-term relationship.
Consider a simple two-by-two matrix: On one axis you have “easy to get along with the founder” and “not.” On the other, you have “an 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 in a significant way for many years, why would you want to include anyone who is hard to get along with? Not only do poor relationships with key people in your life substantially lower your chances of success, they will also make you miserable. Why be miserable? Life is short. Being happy is highly underrated.
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 financially drives many aspects of the 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.
11. “You cannot … 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 model, 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 raising funds, hiring key employees, and even closing big sales, the startup has the wrong venture capitalists.
12. “There is a subtle benefit of actuarial science, which I didn’t appreciate when I joined the profession. Actuaries are trained to think thirty 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 ten or fifteen years.”
Botha trained as an actuary. He points out that a successful venture capitalist must be able to imagine what a startup might look like in ten to fifteen years. In imagining the potential outcome, a venture capitalist needs to think about “what can go right.” Extrapolating the past out fifteen years, as an accountant might do, is not the key to success in the venture capital business.