Sequoia's Conviction-Driven Model for Backing Outlier Founders - Episode Hero Image

Sequoia's Conviction-Driven Model for Backing Outlier Founders

Uncapped with Jack Altman · · Listen to Original Episode →
Original Title: Uncapped #36 | Pat Grady & Alfred Lin from Sequoia

TL;DR

  • Sequoia's internal data indicates that consensus among investors is not a predictor of success; conviction from a few key individuals is a stronger signal for making investments, especially when there's strong disagreement.
  • The firm prioritizes "freedom within frameworks," providing guidelines for capabilities and values while allowing individual partners autonomy to operate their investment strategies authentically.
  • Sequoia focuses on identifying "outlier" founders and teams, enabling them to realize their vision rather than imposing a CEO-like management structure, recognizing that consistency is counterproductive in the outlier business.
  • Effective sourcing involves identifying companies with outlier teams and assessing their potential for future significance, not just tracking deal flow or passing on most opportunities.
  • Sequoia measures partner performance based on adherence to core values and demonstrated capabilities, rather than individual output metrics, to avoid incentivizing unproductive behaviors and focus on long-term goals.
  • The firm emphasizes the importance of "mid-funnel" decisions, believing that the most critical choices occur before a deal reaches a partner meeting, requiring rigorous debriefs and context gathering.
  • Sequoia's approach to winning deals involves demonstrating genuine love for the founder and company through thorough homework and authentic engagement, building trust over time rather than relying on transactional tactics.

Deep Dive

Sequoia Capital's new stewards, Pat Grady and Alfred Lin, emphasize conviction over consensus in investment decisions, viewing their role as enabling a team of outlier investors to find and nurture the next generation of category-defining companies. This approach necessitates a culture that prioritizes founder-centricity, courage, and a deep understanding of individual investor strengths, moving away from traditional hierarchical management to empower unique talents within established frameworks.

The core of Sequoia's strategy lies in identifying and backing outliers, which requires a different operational model than consistency-driven businesses. Instead of imposing rigid directives, their objective is to provide frameworks for their exceptional partners to operate independently, allowing for diverse approaches to sourcing, picking, and nurturing investments. This freedom within frameworks is crucial because the venture business is inherently about taking risks on future potential, not replicating past successes. Consequently, success is measured not by avoiding mistakes (a 50% write-off rate in their best fund is acceptable), but by the presence of conviction in bold bets that can yield asymmetric returns. This philosophy extends to how they onboard founders, focusing on building trust through demonstrated competence and pure intentions, aiming to be a long-term partner rather than just a capital provider.

The implications of this model are profound. It shifts the focus from measurable, short-term inputs to the long-term, often intangible, outputs that define outlier companies. For instance, the "talent map" of Silicon Valley, built over a decade by tracking relationships and expertise, serves as a proprietary data source that informs investment decisions, prioritizing deep understanding of human capital over transactional metrics. Furthermore, this approach requires investors to cultivate courage, enabling them to resist the "fear of missing out" and the "fear of looking stupid" when making non-consensus bets. By cataloging psychological biases and emotional traps that lead to poor decisions, Sequoia actively coaches its partners to embrace calculated risks. This philosophy also dictates how they handle passing on investment opportunities; instead of a simple "no," they aim for gracious, insightful passes that can even help founders improve their businesses, thereby maintaining strong relationships for future opportunities and reinforcing their brand as deeply committed partners. The ultimate goal is to foster a stable partnership that can support the necessary volatility of individual partners pursuing ambitious, outlier investments, ensuring the firm's continued success in identifying and scaling transformative companies.

Action Items

  • Audit investment conviction: For 5-10 recent investment decisions, analyze the distribution of partner conviction scores (0-10) to identify patterns where consensus outweighed conviction.
  • Create conviction-building framework: Define 3-5 criteria for assessing conviction beyond consensus, focusing on identifying strong "yes" or "no" signals from partners.
  • Develop founder-market fit assessment: For 3-5 early-stage companies, document specific questions and observational techniques to rigorously evaluate founder-market fit.
  • Implement post-meeting debrief protocol: Mandate a 15-minute debrief after every significant meeting to capture immediate impressions and rationale for decisions.
  • Track asymmetric upside sourcing: For 5-10 sourced opportunities, document the rationale for pursuing them based on asymmetric upside potential, not just current market size.

Related Episodes

Key Quotes

"the number that everybody votes on every investment for more than a decade now our internal data shows that consensus versus non consensus does not matter at all it's just not a factor presence of conviction is what matters and so if everybody is a six we vote zero to 10 no fives so six and above is positive four and below is negative if everybody's a six probably shouldn't make the investment it's consensus but nobody has conviction strong yes strong no is much better if three people are are nines and three people are ones we should probably make the investment"

Grady and Lin argue that in investment decisions, the presence of strong conviction from a few individuals is more important than widespread agreement. Grady explains that their internal data indicates consensus among investors does not correlate with investment success. Lin further clarifies that a situation with strong "yes" and strong "no" votes is preferable to a lukewarm consensus, suggesting that conviction, even if divided, is a better indicator.

"Consensus doesn’t matter, conviction does. Freedom within frameworks: see, pick, win, help, harvest. Mid-funnel decisions are the most important. The two fears that lead to bad decisions. To do this business well, you need courage."

Grady and Lin highlight several core principles for success in venture capital. They emphasize that conviction, rather than consensus, is key to making sound investment choices. They also outline a framework for their investment process, which includes stages like "see, pick, win, help, harvest." Furthermore, they identify mid-funnel decisions as critical and point to the fears of missing out and looking foolish as significant hindrances to good decision-making, underscoring the need for courage.

"I think our business is dramatically different because in our we're in the outlier business our objective is not consistency right our objective is to find the two or three or four outliers in any given year who are going to produce the most important companies of tomorrow yep get into business with them and help them realize the maximum version of their dream and the and the keyword here the operative word is outlier okay and so in order to partner with outliers we need to field a team of outliers"

Grady explains that venture capital is fundamentally different from other businesses because its objective is to identify and support outliers, not to achieve consistency. He states that their goal is to find exceptional companies that will shape the future and help those founders achieve their vision. To achieve this, Grady emphasizes the necessity of building a team composed of similarly exceptional individuals, or outliers, who can effectively partner with the companies they invest in.

"freedom within frameworks okay so we do have frameworks that people can use as guidelines so that they're not so it's not pure chaos right and so there's a framework that is what are the capabilities that you need and there were five basic steps in the value chain sourcing picking winning building and harvesting and then there's a framework which is what are the values that we expect you to have different teams have different values inside of sequoia sequoia itself has the two primary values of performance and teamwork but there are certain values that we expect people to adhere to assuming you're developing the capabilities and assuming that your values are aligned with the values of your team and of our organization you can operate the business however you want"

Lin describes Sequoia's approach as "freedom within frameworks," providing guidelines without imposing rigid control. He explains that they have frameworks for necessary capabilities, outlining five steps in the value chain: sourcing, picking, winning, building, and harvesting. Lin also notes that there are expected values, with "performance" and "teamwork" being primary for Sequoia. He asserts that as long as individuals develop their capabilities and align with organizational values, they have autonomy in how they operate.

"our internal data shows that consensus versus non consensus does not matter at all it's just not a factor presence of conviction is what matters huh and so if everybody is a six we vote zero to 10 no fives so six and above is positive four and below is negative if everybody's a six probably shouldn't make the investment it's consensus but nobody has conviction strong yes strong no is much better if three people are nines and three people are ones we should probably make the investment because the presence of the nines is a much more powerful signal than the presence of the ones"

Grady reiterates that their data indicates consensus is not a predictor of success, but conviction is. He uses a hypothetical voting system (0-10) to illustrate that a unanimous vote of "six" (lukewarm agreement) is less valuable than a split vote with strong opinions, such as three "nines" (high conviction) and three "ones" (low conviction). Grady suggests that the strong conviction of the "nines" is a more significant signal for making an investment.

"the two fears that lead to bad decisions you've got to kind of block out those fears we do on this note we do a lot of introspection post mortems post parades on decisions that we got right or wrong just got to looking at the outlier decisions one way or the other and saying okay like we got this one really wrong why we got this one really right why what's interesting about the ones that we get really wrong every single one of them if you play the five ys game like why why why why why every single one of them comes down to some psychological bias or emotional trap totally none of them come down to an error in calculation all of them come down to these background effects that were clouding your judgment"

Grady and Lin discuss the detrimental impact of two primary fears: the fear of missing out (FOMO) and the fear of looking foolish. They advocate for blocking out these fears and emphasize the importance of introspection through post-mortems on both successful and unsuccessful decisions. Grady notes that their analysis of wrong decisions consistently reveals psychological biases or emotional traps, rather than calculation errors, as the root cause, highlighting the need to identify and mitigate these underlying influences.

Resources

External Resources

Books

  • "The Contrarian's Compendium" by Alfred Lin - Mentioned as a hypothetical book that could encapsulate the principles of taking contrarian investment stances.

People

  • Alfred Lin - Partner at Sequoia, co-steward of the firm, led investments in Airbnb, DoorDash, and Kalshi.
  • Pat Grady - Partner at Sequoia for nearly 19 years, leads growth-stage investing, backed Snowflake, OpenAI, and Harvey.
  • Jack Altman - Host of the "Uncapped with Jack Altman" podcast, founder of Altcap.
  • Ruoloff - Mentioned as a historical figure who started Sequoia's legacy.
  • Doug - Partner at Sequoia, mentioned in relation to sourcing strategies.
  • Jim - Partner at Sequoia, mentioned in relation to whiteboard sessions and strategic thinking.
  • Andrew Reed - Member of the Sequoia team.
  • Luciano Alexandru - Member of the Sequoia team.
  • David Khan - Member of the Sequoia team.
  • Constantine Beuler - Member of the Sequoia team.
  • Ravi Gupta - Mentioned as the source of the "demanding and supportive" value.
  • Dean Meyer - Partner at Sequoia in Israel, known for mapping talent nodes.
  • Charlie - Partner at Sequoia, described as having a high-volume market approach.
  • Nate - Mentioned as the individual who built all of Airbnb's systems early on.
  • Near Zuk - Founder of Palantir Networks, who was a disproportionate contributor to its early engineering.
  • Brandon - Co-founder of HubSpot.
  • Dormesh - Co-founder of HubSpot.
  • David Cancil - Founder of Performable, acquired by HubSpot.
  • Elias Torres - Founder of Performable, acquired by HubSpot.
  • Chris Fralick - Joined HubSpot via the Performable acquisition and built the CRM.
  • Whitney Sorenson - Joined HubSpot via the Performable acquisition and is currently the CTO.
  • Andrew Veleki - Founder of Klaviyo, was part of the Performable team.
  • Brett Record - Former partner at Sequoia who originated the idea of a talent map.
  • Mark - Mentioned in relation to passing on early Latus rounds.
  • Mike Moritz - Mentioned as the Sequoia partner who made gracious passes on Zappos.
  • Tony - Mentioned as the founder of DoorDash.
  • Brian - Mentioned as the founder of Airbnb.
  • Travis - Mentioned as the founder of Uber.

Organizations & Institutions

  • Sequoia - Storied venture capital firm, recently named Alfred Lin and Pat Grady as new co-stewards.
  • Airbnb - Category-defining company, major investment led by Alfred Lin.
  • DoorDash - Category-defining company, major investment led by Alfred Lin.
  • Kalshi - Category-defining company, major investment led by Alfred Lin.
  • Snowflake - Company backed by Pat Grady.
  • OpenAI - Company backed by Pat Grady.
  • Harvey - Company backed by Pat Grady.
  • Altcap - Company founded by Jack Altman.
  • Pro Football Focus (PFF) - Mentioned as a data source for player grading in an example.
  • Summit Partners - Investment organization mentioned as a strong training ground for aspiring investors.
  • Palantir Networks - Company that had an amazing engineering organization, with Near Zuk as a key contributor.
  • ServiceNow - Company Sequoia invested in in 2009, with code initially written by one person.
  • HubSpot - Company Sequoia invested in in 2011, which rebuilt its platform after acquiring Performable.
  • Performable - Company acquired by HubSpot, run by David Cancil and Elias Torres.
  • Clavio - Company founded by Andrew Veleki.
  • Open Evidence - Vertically integrated foundation model for medicine.
  • Latus - Mentioned in relation to early rounds where Sequoia passed.
  • Zappos - Company Sequoia passed on multiple times before investing.
  • Link Exchange - Company where Mike Moritz was involved and Sequoia passed on early rounds.
  • Octa - Company Sequoia led four consecutive rounds in (Series C, D, E, and F).
  • Zoom - Company Sequoia invested in, which was not initially a consensus investment.

Websites & Online Resources

  • sequoiacap.com - Website for Sequoia Capital.
  • x.com/gradypb - Pat Grady's X (formerly Twitter) profile.
  • x.com/Alfred_Lin - Alfred Lin's X (formerly Twitter) profile.
  • www.altcap.com - Website for Altcap.
  • x.com/jaltma - Jack Altman's X (formerly Twitter) profile.
  • linktr.ee/uncappedpod - Linktree for the Uncapped podcast.

Other Resources

  • Uncapped with Jack Altman - Podcast where the discussion took place.
  • Consensus vs. Conviction - Investment principle discussed, emphasizing conviction over group agreement.
  • Freedom within Frameworks - Principle for operating within guidelines while allowing autonomy.
  • Mid-funnel decisions - Highlighted as the most critical decisions in the investment process.
  • The two fears that lead to bad decisions - Fear of missing out (FOMO) and fear of looking stupid.
  • Stewardship - Concept of leading and guiding Sequoia into its next generation.
  • Founders first, LPs second, Sequoia third, the team fourth, yourself fifth - Sequoia's stated priority order.
  • "We'll always do the right thing and do it the right way" - Core value of Sequoia.
  • "We'll always apologize, fix it, and move on" - Sequoia's approach to handling failures.
  • Outlier business - Sequoia's focus on finding and backing outlier companies.
  • Team of outliers - The type of team Sequoia aims to build to partner with outlier companies.
  • Sourcing, Picking, Winning, Building, Harvesting - The five basic steps in the value chain.
  • Performance and Teamwork - Two primary values of Sequoia.
  • "Separation of church and state" - Concept of separating the thrill of the chase from clinical decision-making.
  • Net multiple money returns - The primary objective function for Sequoia's limited partners.
  • Founder-market fit - A key lens for evaluating potential investments.
  • Proprietary map of talent - A system for mapping skilled individuals within Silicon Valley.
  • Talent nodes - Key individuals or groups with significant expertise.
  • PageRank for people - An analogy for the talent mapping system, ranking individuals based on connections.
  • Giving before getting - A principle for building relationships and trust.
  • Emerging market leader, unique and compelling value prop, sustainable competitive advantage - The "spec" or shared language for growth-stage investing.
  • Mid-funnel decision - The critical decision point that determines what progresses to a formal review.
  • Debrief - The practice of discussing meetings and decisions afterward to aid memory and analysis.
  • Thinking fast and thinking slow - The need to balance immediate impressions with deliberate analysis.
  • Competence and Intention - The two components of trust in a founder-investor relationship.
  • Board member role - To be a sounding board and provide pattern recognition, not to operate the business.
  • Novelty gene - The tendency for venture capitalists to be attracted to new and novel ideas.
  • Stability over time - The importance of building stable, core business practices.
  • Volatility at the partner level - Allowing individual partners to pursue unique strategies within a stable partnership.

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