Dialogue with Sequoia Capital Roelof Botha: AI development is overheated, rapid growth does not mean success

Source: Lessons from 20 Years of Venture Capital: Roelof Botha (Managing Partner at Sequoia Capital)

Organize & compile: Daisy, ChainCatcher

Editor 's note:

Against the backdrop of the rapid development of artificial intelligence technology, AI investment continues to heat up, and the decision-making logic of venture capital is also constantly changing. Roelof Botha, managing partner of Sequoia Capital, shared his judgment on the current market stage, AI investment risks, and how Sequoia can deal with decision-making errors within Sequoia.

He reviewed his experience in crisis management at PayPal, pointing out that in an environment of capital-rich, companies are prone to strategic loosening. At the same time, he also explored how to assess the long-term potential and market caps of early-stage high-growth companies, and the importance of adhering to investment discipline in specific situations.

This dialogue provides an entry point to examine the AI ​​entrepreneurship cycle from the perspective of venture capital, covering practical experience in risk control, psychological bias and investment strategies.

The following content is the compilation and compilation of the interview.

TL;DR: (too long,didn't read)

1. From the overall market perspective, there is no systematic bubble. Of course, there is indeed overheating in some areas, such as the field of artificial intelligence.

2. Acceleration of company growth is part of the general trend, not an occasional phenomenon.

3. The rapid growth of startup projects in the early stages does not mean that they have a foundation for long-term success, and they need to pay attention to market caps and sustainability.

4. When investing, if you only look at the early growth curve, it is easy to misjudgment the future upper limit. Early investors must think: Can this model truly become a public behavior?

5. Rapid growth does not mean success.

6. Overcapacity can easily lead to slack in corporate strategies, and when resources are limited, it can inspire maximum innovation and execution.

7. People are easily affected by the information they first come into contact with.

8. Sequoia reduces the interference of cognitive bias on decision-making through institutionalized processes (such as horizontal comparison of investment projects, open identification of psychological bias, etc.).

9. Long-termism and collective judgment are the core principles of Sequoia to maintain rationality in volatile markets.

Current market and investment rationality

Mario: Do ​​you think there is a bubble in the current market?

Roelof: By my standards, I don't think it's a bubble. For me, bubbles mean that the prices of various asset types are generally expanding in various fields, but this is not the case now. For example, the US real estate market, whether residential or commercial real estate, is still weak overall. We have an internal tracker in Sequoia, updated every Monday, tracking the multiples of enterprise value and revenue of approximately 690 listed tech companies. Judging from this statistics, the current overall level is about the 60th percentile in the past twenty years. In other words, from the overall market perspective, there is no systematic bubble. Of course, there is indeed overheating in some areas, such as the field of artificial intelligence, but this is not the case overall.

Mario: Apart from weekly tracking reports, what other ways do you have to be rational when evaluating investments?

Roelof: In addition to market multiple tracking, we also have a tool, which is to record all completed investment cases of the current fund. This allows us to constantly look at the projects we have recently invested in and compare them with those we have invested in in the past. Because humans naturally tend to make relatively comparisons in decision-making. If you only look at projects you encountered in the past month today, the standards are easily pulled down or raised by the current environment. But if you relax your horizons to the entire fund investment cycle, or even longer, you can more accurately judge the absolute quality of a project - whether the company has the potential to become a "legendary company". Sequoia has been established for more than 50 years and supports companies that account for more than 30% of the market value of today's Nasdaq. This fact also requires us to always demand ourselves to the highest standards.

Mario: With the rapid development of artificial intelligence, are there more and more companies standing out?

Roelof: Indeed, it takes less time for a company to grow to a considerable scale today than ever before. But this is not a sudden new phenomenon, but the result of the continuous evolution of the past few decades. From semiconductors to computer systems, to the Internet, to mobile Internet, and to today's artificial intelligence, every technological leap is lowering the threshold for enterprises to reach users and speeding up product promotion. Especially today, more than 5 billion people around the world are connected to the Internet, most of which have smartphones, which means new services can reach the global market almost instantly. In addition to the accumulation of data in Shanghai, it provides rich fuel for the development of AI. Therefore, accelerated company growth is part of the general trend, not an occasional phenomenon.

Mario: In the current context of rapid development, is the biggest challenge for investors judging the ceiling of opportunities?

Roelof: That's true. The first is to judge the upper limit of market size. For example, the flash purchase e-commerce companies that were once very popular fifteen years ago (such as Gilt and Rue La La), had an extremely steep growth curve at that time, and was impressive. But it turns out that the flash sale model has not become a mainstream consumption method, but is limited to the niche market. When investing, if you only look at the early growth curve, it is easy to misjudgment the future upper limit. Therefore, early investors must think about a question: Can this model truly become a mass behavior? The second is the issue of competition barriers. The leader may not necessarily win in the end. For example, Google is not the first search engine, and Facebook is not the first social network. In many technical fields, they are often the second and third entrants, summarizing the experiences and lessons of their predecessors, and ultimately achieving transcendence. Therefore, when investing, we must not only judge the market size, but also evaluate whether the company's moat is deep enough and whether it can continue to lead.

Mario: You mentioned that there have been SPV (special purpose entity) investment, a small amount of self-investment, and a large amount of foreign investment in the AI ​​field. Is this a signal of a bubble?

Roelof: This phenomenon is mainly concentrated in the field of AI. My point is: Even if the overall market is not a bubble, local areas may be overheated. Furthermore, I am worried that this rash investment method will undermine market health, especially for startups themselves. Looking back on my personal experience, PayPal faced huge financial pressure in 2000. It was precisely because of the restrictions on "burning money" that the team focused on innovating, optimizing business models, and reducing costs. Over-financing will instead cause the company to lose this sense of crisis and become slack, which is not conducive to building healthy long-term businesses.

Risks and misjudgments behind high growth

Mario: In reality, can the founder still maintain self-discipline and rationality after obtaining huge financing?

Roelof: Very rare. What can be truly achieved are often founders who have experienced major crises and experienced moments of life and death. For example, Airbnb's Brian Chesky experienced a crisis of nearly collapse during the 2020 pandemic. This experience gave him a deep understanding of capital and risks. I believe that people like him can maintain caution and discipline even if they get sufficient funds in the future. But for most founders who have not experienced similar suffering, it is difficult to resist the temptation of relaxation brought by abundant capital by relying solely on rational self-discipline.

Mario: It seems that only by experiencing pain can we truly understand the lesson.

Roelof: Yes, so do I myself. In 2000, when I was at PayPal, we lost as much as $14 million in monthly and the company had only seven months of cash left. We initially spent money on expansion, but when the market collapsed and financing channels closed, we were forced to act quickly. During that time, we compressed spending, solved the problem of online payment fraud, and adjusted our income model. Since then, our revenue has grown rapidly for three consecutive years. This experience taught me that when resources are limited, it can inspire the greatest degree of innovation and execution. Therefore, I often recommend that entrepreneurs ask themselves, if there are only 12 months of cash flow left, what decisions would you make today? Such assumptions can greatly clarify what is really important and avoid waste of resources.

Psychological bias and coping mechanism in decision-making

Mario: When did your interest in decision psychology begin?

Roelof: Interest comes from many aspects. First of all, my father is a professor of economics and has been influenced by him since childhood. When I was in college, I majored in actuarial science. This subject requires decades of predictions, which trained me to think about problems on a very long scale. Most people, such as accounting, are used to looking at data from the past year only. When I arrived at Stanford Business School, I took the course of organizational behavior and systematically learned cognitive biases. Since then, I have started reading a lot of books on this. Later in Sequoia, we not only introduced the identification of bias in the team discussion, but even required each investment memorandum to actively list possible psychological biases, such as: "Am I too anxious because I haven't invested for too long? Am I too close because I know the founder?" In this way, explicitizing the bias can greatly reduce their hidden impact on decision-making.

Mario: This method of actively identifying bias is equivalent to adding a layer of protection to decision-making.

Roelof: That's exactly what it is. If you can discuss bias publicly in the team, for example, someone admits: "I think I may be a bit inclined in this case." Then the rest of the team can also participate in judgment more rationally, thereby collectively reducing the impact of bias. We always believe that teams are better than individuals, and group rationality can remedy the blind spots brought by personal emotions.

Mario: What are the most common and vigilant decision-making mistakes do you think are?

Roelof: There are two particularly important ones. The first is the anchoring effect. People are easily influenced by the information they first come into contact with. For example, you looked at a company six months ago, and the valuation was cheap, but now it tripled, so you instinctively resist investment. But the correct question should be: With today's conditions, is this a good time to enter? Instead of tangling past prices. The second is loss aversion. People often withdraw too early when there is already gain, fearing that they have already lost their existing profits, rather than continuing to hold assets with potential to continue to grow. This kind of psychology will make people miss the opportunity for real long-term compound interest. To combat this tendency, we specially set up the Sequoia Capital Fund, which allows us to hold shares in excellent companies after listing for a long time, rather than distributing them to LPs immediately during an IPO.

Mario: Sequoia's establishment of long-term funds is to a certain extent to correct the shortcomings of human nature with systems.

Roelof: That's right. Establishing mechanisms is a way for us to fight our instinctive weaknesses. Relying on individual will is not enough, and it is necessary to improve the rationality of collective decision-making through structured design.

Investment review and long-term mentality

Mario: What are the cognitive biases or wrong decisions that impressed you in your investment experience?

Roelof: Yes. For example, we had the opportunity to invest in early rounds of Twitter, but eventually chose to give up. One reason is that it is questioning the company's growth data at the time and not understanding its network effect potential with a forward-looking enough. After reviewing the matter, this is actually a mistake of over-reliance on short-term quantifiable indicators and ignoring the possibility of long-term nonlinear growth. This is why in internal education, we later emphasized the need to pay attention to both quantitative data and qualitative trends.

Mario: Companies that really change the world often have not been impressive in the early stages of the data.

Roelof: That's exactly what it is. Legendary companies are often full of uncertainty in the early stages, and their growth paths are not linear and even seem a bit confusing. If you only use traditional financial indicators to solve them, you will often miss them. Therefore, identifying early potential requires a combination of data, trends, founder traits and a more macro market insight.

Mario: In the current AI investment boom, how do you view the rapid growth of startups? What are the risks behind it?

Roelof: Today’s company is growing at a stunning pace. Some companies have earned hundreds of millions of dollars in just a few months. But the question is whether this explosive growth is sustainable. First, market capacity must be evaluated. Some areas have low ceilings and will slow down rapidly after they grow to a certain scale. If you enter when the valuation is already extremely high, the risk is huge. Secondly, it is the competitive landscape. Leading early does not mean you can maintain your lead for a long time. Competitors are constantly emerging, and user stickiness and network effects are the moats that can truly withstand shocks.

Mario: That is, rapid growth does not mean success.

Roelof: It's totally correct. Fast growth is a signal, but it must be comprehensively evaluated based on multiple factors such as market size, moat, profit model, and team execution. Otherwise, you will easily fall into the trap of blindly pursuing high growth.

Mario: In such an environment, how can Sequoia keep the decision-making calm and rational?

Roelof: We have several internal principles. First of all, always adhere to "discount future value rather than tracing past prices". Even if a project was cheap in the past but now it has tripled, if it is still reasonable in terms of long-term value, we will not miss opportunities due to psychological barriers. Secondly, extensive comparison. Every time a new investment decision is made, not only compared with the current case, but also horizontally compare all investments throughout the fund cycle to ensure that the standards do not decline. Furthermore, openly discuss potential biases. Each investment memorandum will ask the person in charge to list their possible psychological biases, such as whether they are too anxious because they have not taken action for too long. Through collective discussion, these biases can be explicitly described, thereby reducing their implicit effects on decision-making.

Mario: Sequoia seems to attach great importance to self-reflection within it.

Roelof: That's right. We believe that only by constantly examining ourselves can we maintain excellent decision-making levels in the long run. The market environment changes extremely quickly, and taking it lightly at any time will lead to catastrophic consequences. For fifty years, Sequoia has been able to continue to succeed because of this culture of continuous self-iteration.

Mario: What advice would you give to young investors or entrepreneurs?

Roelof: Stay curious and stay humble. Curiosity drives you to learn new things constantly, while humility reminds you to always realize that your cognition is limited. Don’t be complacent because of short-term success, and don’t be discouraged because of short-term setbacks. True great causes are all achieved through constant trial and error and correction.