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Sequoia Capital’s Reticent Partner Tells All February 1, 2007

Posted by rajAT in Uncategorized.
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Sequoia Capital is one of the most prestigious venture firms in the world. It backed Cisco Systems, Google, Oracle, Yahoo! and YouTube. Douglas M. Leone was Sequoia’s busiest partner last year. In 2006, Leone managed Sequoia’s moves into India and China and signed seven new deals, including: a $48 million late-stage investment into Idea Cellular, an Indian wireless provider; NetShops, a group of online stores that is headquartered in Omaha, Neb.; and WorkSoft Creative Software Technology, a Beijing outsourcing firm.

Leone, an industrial and mechanical engineer, broke into tech as a salesman at Sun Microsystems (nasdaq: SUNWnews people ) and Hewlett-Packard (nyse: HPQnews people ) before joining Sequoia nearly 20 years ago. His exits include Hyperion Solutions (nasdaq: HYSL news people ), Sentient Networks (Cisco (nasdaq: CSCOnews people )) and Telera (Alcatel-Lucent (nyse: ALUnews people )).

In a rare media interview, Leone talks with Forbes about what constitutes a great company, how to harness violent growth and entrepreneurs who fold too early.

What makes a company successful?

Leone: So many VCs say they will only invest in great managers, people who have done it before. But Bill Gates didn’t do it before. Larry Ellison didn’t do it before. McNealy, Jobs , none of them did it before.

A tremendous chief executive in a small market will never be great. All great companies start with great markets.

Right, but what makes a market a great market?

The trick is, a market has to be nonexistent when you start. If the market is large early on, you will have too many competitors. You have to make it large.

It’s one of the reasons Sequoia went into India and China. Those domestic markets are very small now but will become very large. We have raised $200 million for deals in China, $200 million for early-stage deals in India and $400 million for later-stage deals in India.

How do you build a company to serve a market that doesn’t exist?

Ha! We like the kind of entrepreneurs who can see the future. When that happens, you get this. [Leone whips out a dry erase marker and walks over to the whiteboard. He draws a dot, then a line that steadily moves up and to the right.] When the flywheel of a company that has created its own market gets going, it grows much faster than you expect. [He continues the line he has drawn in a sharp ascent.] Then it becomes an almost violent growth.

If you choose a market that already exists, say, networking equipment, you have to compete with an established company like Cisco. Even if your product is marginally better, Cisco can fudge it and outsell you.

What do you think about mergers versus public offerings as exit strategies?

I’ll say this: I can’t think of one instance in my 20 years in venture capital in which I have wanted to sell a company before the entrepreneur.

How can a deal happen, then? After all, you are a director and shareholder.

We’re forced to go along with management. If management wants to sell and you don’t, you end up with a very unmotivated team. And that leads to failure.

Why would an entrepreneur want to sell early?

Sequoia tends to work with first-time entrepreneurs. When an entrepreneur has gotten here [Leone points to the far right corner of his “violent growth” diagram], he’s never experienced anything like it before. He does not know that it can last, can continue in this direction. He’ll accuse us of portfolio theory [that a VC firm can afford to hold out because its risk is spread across multiple companies] and say that the founders have all their shares in this one company and someone is offering them big money for what they have built.

The truth is, we’ve seen this 30 times before, and we know what the leading indicators are to success. We recognize it when we see it because we have seen it before. We know when something can become much more.

So what happened with YouTube?

Left to our own devices, we would have kept on going. Maybe it’s long-term greed. But the public market voted. They must have agreed it has potential, because Google’s (nasdaq: GOOGnews people ) stock went up after the acquisition.

All the most successful companies we have seen at Sequoia–Network Appliance (nasdaq: NTAPnews people ), Cisco, Google, Yahoo! (nasdaq: YHOOnews people )–in their private lives, someone put an offer in front of them. But they didn’t take it.

We had the chance to sell Aruba two years ago. We had multiple inquiries from acquirers, but we decided not to sell. And now we’ve filed for a public offering. I pushed very hard for that. I thought we had a chance to build something for the future.

Not every company in which Sequoia has invested has made it to an IPO. How do you know when to sell?

If you have a limited market, it becomes evident to the whole board that things are tough, and the entrepreneur will have to raise more money and get diluted. So you talk about a deal.

What would you advise entrepreneurs to think about when considering an M&A deal?

Having a long-term, successful investor who thinks about the best interest of your business is key. But with many M&A deals, there are often dynamics that go against the entrepreneur’s interest. Maybe a venture firm has not done well and it needs to show its limited partners [the investors in a VC fund] a win. Or maybe an inexperienced VC without experience needs a win.

How do you get a company to that “violent growth” point?

No one can plan for that kind of success. None of today’s wonderful companies planned to be very big. Not for a second did [Yahoo! founders] Yang or Filo understand the potential of an Internet portal when we funded them. Nor did [YouTube founders] Chad or Steve understand the potential of user-generated video growth. What they understood was a need. Being focused on solving one problem is a precursor to something big.

But if all these great companies started off so small, how do you ever see the big vision that gets you to that point of violent growth?

We don’t see any big vision. We’re just as blind as the entrepreneurs.

So what do you do to help them, other than provide financing?

We build structure around them. We give them an action plan. We tell them to just keep the business running, think about what their customer really needs, not what they think he needs. You can’t start looking into the future for a long time. All we can do is help the entrepreneur execute on a series of rapid, small steps. Later, it ends up becoming something greater.

 

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