还原VC投资的残酷真想：为什么只有红杉能一直笑到最后The Brutal Truth About VC: Why Sequoia Gets the Last Laugh

Preface

Do you want to work at Sequoia Capital?

01 China's Internet, Ruled by Sequoia

First, look at a few numbers.

Among US-listed Chinese stocks, there are 3 companies valued above the hundred-billion-dollar level (unit: USD):
Alibaba (BABA): $541.159 billion
Tencent: $523.695 billion — ¥4.06 trillion
Meituan: $103.783 billion — ¥804.706 billion

There are 12 companies in the tens-of-billions class:
Pinduoduo (PDD): $77.714 billion
JD (JD): $76.963 billion
NetEase (NTES): $49.892 billion
Xiaomi: $39.867 billion — ¥309.119 billion
Baidu (BIDU): $37.348 billion
TAL Education (TAL): $33.922 billion
ZTO Express (ZTO): $25.210 billion
New Oriental (EDU): $18.536 billion
Trip.com (TCOM): $15.444 billion
iQiyi (IQ): $11.643 billion
Bilibili (BILI): $11.511 billion
Vipshop (VIPS): $10.745 billion

There are 7 valued above $5 billion:
Huazhu (HTHT): $9.501 billion
Autohome (ATHM): $9.106 billion
Weibo (WB): $6.751 billion
58.com (WUBA): $7.304 billion
GSX (GSX): $7.406 billion
SMIC (SMI): $5.898 billion
YY (YY): $5.045 billion

Looking back: of the 3 companies in the hundred-billion class, Sequoia hit 2. Of the 12 tens-of-billions companies, setting aside the two special cases of New Oriental and TAL, that leaves 10—and Sequoia hit 6 of them, taking more than half into its pocket, plus Trip.com, which Neil founded himself. After Sequoia, the most was IDG with 5 and Toutiao's fund with 4.

Alibaba: Sequoia; GGV; SoftBank China; DST
Meituan: Sequoia; Alibaba; Northern Light; Tencent; DST
Pinduoduo: IDG; Gaorong; Lightspeed; Sequoia
JD: Today Capital; Sequoia; Tencent; DST
NetEase: Today Capital
Baidu: IDG
TAL: Hillhouse
ZTO: Sequoia
New Oriental: never raised financing
Trip.com: IDG; Morningside; Today Capital; SoftBank China
iQiyi: IDG; Sequoia
Bilibili: IDG; Qiming
Vipshop: Today Capital; Sequoia; DCM; Tencent

Of the 7 companies valued above $5 billion, Weibo is a special case—no mainstream VC involved—and Sequoia hit 1. DCM had the most, with 2.

Huazhu: IDG; Northern Light
Autohome: no mainstream VC
Weibo: Alibaba (no mainstream VC)
58.com (Ganji): DCM; Warburg Pincus; Tencent; BlueRun; Today Capital; Sequoia
GSX: Gaorong
SMIC: DCM
YY: Morningside; GGV

Among the just-listed and not-yet-listed unicorns valued above $10 billion, Sequoia hit 10 of 11—TMD (Toutiao, Meituan, Didi) all in; only Xiaomi slipped away, which in turn made Morningside a historic-level return.

Xiaomi: Morningside; Shunwei; Qiming; IDG; DST
Toutiao: Shunwei; Source Code; SIG; DST; Sequoia
Didi: GSR; Tencent; Matrix; DST; GGV; Sequoia; Alibaba
DJI: Sequoia
Kuaishou: Sequoia; Tencent; Morningside; DCM; Shunwei
Bitmain: IDG; Sinovation; Sequoia
VIPKID: Sequoia; Matrix; ZhenFund; Tencent
Beike: Source Code; Sequoia
JD Digits: Sequoia; Matrix
Guazi: Sequoia; Matrix; BlueRun; DST; Today Capital; IDG; Tencent
The four AI dragons: Sequoia backed Yitu
Ant Financial, Cainiao, and Lufax are special cases

3 + 12 + 7 + 11 = 33 companies; Sequoia hit 2 + 7 + 1 + 10 = 20—a 60% share.

Among the already-listed China ADRs, Sequoia is the biggest winner; and among the unicorns large and small riding the mobile-internet wave, Sequoia stands truly peerless, its hit rate second to none, never letting a major unicorn slip away, holding an absolutely dominant, monopolistic edge: TMD all in, only Xiaomi the exception; Tencent hit 6, but Tencent can't be classed as a mainstream VC; second is Russia's DST, with 5. The most for anyone else is 3 (Shunwei; IDG; Matrix); Morningside with 2.

Toutiao and Kuaishou made SIG, GSR/Matrix, and Morningside, respectively; Pinduoduo made Gaorong/Lightspeed.

There used to be a saying: why do mainstream VCs miss the A rounds of the big unicorns? Later it grew into another: OK, you missed the A round—but the B round? Where were you at the B round? Using Sequoia as the entry point, let me clear up this fog for you.

Sequoia's dominance, in my view, comes down to the following points, none of which can be missing:

a. The most explosive phase of China's GDP growth
b. An extraordinarily keen nose for TMT, plus the nature of the industry itself
c. Enormous capital scale
d. An enormous brand moat, painstakingly built

02 The Opportunity of the Era

(Figure in original — an overview of China's annual GDP growth rates over the years)

In 2001, China joined the WTO. From 2005 to 2020 was the single most explosive phase of China's GDP growth. Across 2005-2010-2015-2020, over 15 years, China's GDP grew as follows: 37,198 — 63,668 — 96,474 — 129,626.
United States: 143,636 — 149,999 — 167,088 — 185,078
Japan: 57,811 — 57,343 — 61,621 — 64,359
Germany: 33,897 — 35,178 — 38,867 — 41,840
United Kingdom: 24,341 — 25,152 — 27,827 — 30,242
France: 26,681 — 27,648 — 29,201 — 31,314
India: 10,845 — 16,054 — 22,922 — 32,373

From 2005 to 2020, China grew 3.48x; the US, 1.29x. China's average annual growth was 8.68%; the US's, 1.70%.

And after 2030, by rough, conservative estimate, the 2030-2035-2040-2050 numbers look like this:
China: 229,450 — 291,100 — 355,191 — 480,339
United States: 214,559 — 228,807 — 244,984 — 279,289
India: 64,547 — 90,031 — 125,210 — 213,699
Japan: 67,181 — 67,869 — 67,755 — 68,813
Germany: 45,415 — 46,515 — 48,350 — 51,599
France: 35,847 — 37,936 — 40,286 — 46,237
United Kingdom: 35,130 — 37,314 — 39,821 — 45,196

The opportunity of history matters more; a person is far too small.

03 TMT: One General's Glory Built on Ten Thousand Bones

TMT stands for Telecommunications, Media, and Technology—the initials of those three words—arising from the converging trends of future telecom, media/tech (the internet), and information technology.

TMT has its own distinctive mode of value creation. Before we get there, a relevant and important concept: "economic profit" (calculated as net operating profit minus the cost of capital).

In accounting, profit is calculated as revenue minus cost. In the "devil's-advocate economics" calculation of profit, it's revenue minus "all costs"—opportunity cost above all.

Take an example. Suppose our friend Klay invests 200,000 yuan to open a milk-tea shop, and a year later the shop has made 100,000. That 100,000 is the accounting profit—looks like a gain, right? But opening the shop carries other hidden opportunity costs. For instance, if he hadn't opened the shop, that 100,000 placed elsewhere—say, buying Apple stock—might have earned 150,000; and if he'd gotten lucky and backed a business genius whose company went public a few years later, he might have earned 200 million. So the milk-tea shop's "economic profit" = 100,000 revenue − 150,000 stock gain − 200 million opportunity cost, a massive loss.

Taking opportunity cost seriously is the defining feature of economic profit. Economic profit is the most extreme concept of profit, because it counts every cost. We might even say that only enterprises capable of creating economic profit have truly created "value."

Industries with low economic profit are crowded with wolves and short on meat—fully competitive. Industries with high economic profit must have some high barrier that shuts a portion of players out of the competition. Of course, in the end, economic profit essentially gets ground to the edge of zero—because as long as you have economic profit, new competitors will keep flooding in. So generally, the long-established, traditional industries like highways and railways have economic profit that's even negative. But TMT, when it comes to creating economic profit, is different.

McKinsey once ran a study covering 2,400 listed companies worldwide across 59 industries, and in TMT's five sub-industries—software, consumer electronics, media, telecom, and cable operators—economic profit stood peerless (see figure below). If your investments perfectly avoided tech companies, it can only mean your judgment was truly "excellent."

(Figure in original — average economic profit by industry, 2010-2014, TMT industries in orange bars, McKinsey)

By McKinsey's estimate, from 2000 to 2014 the economic profit of the TMT industry multiplied more than 100-fold.

Look more closely at TMT's economic profit and you find one of its most important features—the Matthew effect, winner-take-all. TMT is the most ruthless industry for top companies, arguably without peer. From 2010 to 2014, the top 20% of TMT companies seized 85% of the industry's total economic profit, while the top 5%—those FANG heavyweights—took more than 60% of the pie. Doesn't that look strikingly similar to Sequoia's numbers at the start?

(Figure in original — TMT economic profit highly concentrated in top companies, McKinsey)

So why can they achieve winner-take-all? The answer is: network effects, which raise industry standards sky-high.

A network effect is a mechanism within a product and a business.

It means that adding new users creates value for existing users. That is, the total experience and value grow as the number of users grows. The principle is that users derive value from one another; in such a network, every user is both a producer and a consumer.

For example: I write articles, and I also read them. I post to Weibo, and I also read what others post to Weibo. So I'm both producer and consumer.

Network effects help you build a better, faster-growing, higher-value product, and are the most crucial driving force for many software companies. Today, as the factors that can build a business "moat"—brand, regulation, supply-chain scale, and patents—come under constant threat, and as software keeps "eating the world," network effects grow ever more important for building competitive "barriers" against rivals.

A network effect is a mechanism within a product and a business. With it, every additional user makes the product/service/experience more valuable to other users. That's why the software companies whose products venture-capital firms seek out and invest in all have "network effects" present.

Network effects are so formidable and so important because they are the best form of defense in the digital world—and therefore the best form of value creation (the other three great forms of defense being brand, embedding, and scale).

Alex Iskold argues that network effects are a very important and yet very puzzling subject. The reason they matter is that true network effects can deliver high retention and engagement, raise market share, and extend a product's life cycle.

Over the past several decades, network effects have created the vast majority of value in the tech industry, because in tech, the winner-take-all companies are almost all driven by network effects. Network effects have reached, or are about to reach, every industry—the more people use it, the greater the value, growing exponentially.

In traditional industries, product superiority is king. Gree has a good brand, but if I can make a product identical in every other respect that saves 25% on electricity, I'll surely carve off a slice of Gree's share. But in TMT's logic, even if I build a product better than Alipay, that product's only real use is probably to get bought up by Alibaba—and even that isn't very likely to happen.

Top companies dominate the industry standard through network effects; the 72:1 rule makes the strong stronger, so the winner takes all, going all in on market share, while the underdog can only face the odds of elimination, acquisition, or failure.

And Sequoia, on the strength of an extraordinarily keen nose and understanding of TMT, became the biggest winner of this wave.

04 Money Is Talk — In the Face of Absolute Strength, Even Brand Loyalty Gets Rewired

From the project side, why take X's money and not Sequoia's? Though it's had the occasional unpleasant falling-out with individual startups, one indisputable fact is that "almost no startup doesn't want to land an investment from Sequoia China." Can't think of a reason to turn them down, can you? And if you really do turn them down, Sequoia goes and invests in your competitor.

Looking at the rounds in which Sequoia entered "whales" valued above $10 billion: Meituan (A round), Toutiao (C round), DJI (B round), JD Finance (A round), Kuaishou (A round); and among companies valued in the tens of billions of dollars: iQiyi (strategic), Mobike (C round), NIO (B round), WM Motor (entered at B+ round), and so on. Look closely at the specific rounds and you'll find that Sequoia's dominance lies in the mid-to-late stages, but it achieved essentially full coverage of the mid-to-early stages too. In late-stage single checks above $30 million, it basically never missed.

From another angle on the project side, Sequoia's advantage is also plainly obvious. First, as the figure shows, looking at the share of Sequoia China's portfolio companies that advanced to the next round over the past 5 years: 87.8% of companies invested in 2013 had already reached the next round, 63.42% for 2014, 57.92% for 2015, 53.95% for 2016, and for 2017 the share reaching the next round was 18.18%. The 5-year average share of portfolio companies advancing to the next round is 56.25%—that is, more than half of projects can make it to the next round.

(Figure in original — share of Sequoia China portfolio companies advancing to the next round, 2013-2017)

Beyond the high share advancing to the next round, the most forceful proof of Sequoia's performance lies in its IPO cases. According to ITjuzi data, as of the end of 2017, Sequoia China's exit cases had reached 58, with 10 completing IPOs in 2017 alone—and the vast majority of these companies were entered at the A round.

On the fundraising side, a newly raised Sequoia fund runs roughly ¥7-8 billion, essentially rivaling the entire scale of another top-tier or near-top-tier firm. With this much money—and with Sequoia never having to worry about getting in or lacking an allocation—you can only marvel: having money really does let you do whatever you please.

Setting aside the specific business performance and commercialization potential of TMD and the rest, the real question is: why is it that after VCs miss the A round of a big unicorn, they aren't seen at the B round either? There are two situations:
① Many funds, having passed on this round, find it very awkward to invest in later ones.
② They want to invest in later rounds but are constrained by their own fund size, are price-sensitive on valuation, and can't get in for lack of an allocation.

On the VC firm rankings, the top three by assets under management roughly equal the combined scale of the next 40 GPs on the same list. Add in the top PE firms, and the 200 GPs on the list—that is, 1% of the 23,000-plus managers registered with the Asset Management Association of China as of this March—control more than 70% of the industry's assets under management.

This is Sequoia's second strength: brand effect and capital advantage. Sequoia currently invests across all stages.

Beyond that, Sequoia has begun venturing into fund-of-funds—the ambition of this top old-line GP in the FOF arena is starting to show.

On March 19, 2018, Genbridge Capital was established, jointly launched by Sequoia Capital, the China State-Owned Enterprise Venture Investment Fund, and several well-known listed internet companies, with a fund size of ¥50 billion at the time. Neil Shen served as chairman, building the core management team, and a former global partner of a well-known international fund-of-funds served as managing partner.

According to reports, Genbridge would screen strictly by market metrics, joining with 50 market-based venture firms to co-invest, committing ¥11.9 billion, for sub-fund total scale of ¥127.506 billion, with a government-capital multiplier of more than 10x, set to drive nearly ¥20 billion of investment by relevant funds into enterprises in the Futian district.

Sequoia China's move into FOF—investing in 9 sub-funds of the new-economy sector via a fund-of-funds and earning excellent returns—forms a "1+9" model, covering a complete ecosystem from early-stage to mature-stage investing, vastly expanding its project resources. This sub-fund ecosystem currently manages more than ¥80 billion, with a total team of over 250 members.

The sheer span of Sequoia's current market reach is genuinely rare in a China private-equity market that is "only" about 20 years old; its use and allocation of capital has already broken out of the VC category. With money, you really can "do whatever you please."

The bar to becoming a GP is going to rise higher and higher; this is the last window in which an MD can transform, indiscriminately, into a GP without a clear exit and fundraising track record. And the earlier institutions and VC 2.0 firms already have to face and ponder: how to differentiate themselves as institutions, how to invest in the tracks they aren't good at, and how to contend with Sequoia's all-stage push.

05 Will RMB Funds Rise in the Future? No—the Dollar Will Stay Strong, Forever

"Dollar funds, dollar funds, and yet more dollar funds... Every single day it's news of another large-scale dollar-fund raise closing. This may well be the inner voice of most practitioners in China's private-equity industry this year."

Many people tell me that domestic RMB funds are bound to rise in the future. Maybe they will—but as to whether our turn will come, or whether we'll see it when we still have the most energy, I hold a pessimistic view. Frankly, in the near term I see no sign of improvement in the current situation. Fiscal money is busy fighting the pandemic, funding requirements grow ever stricter, the industrial side is retrenching, and the personal-wealth side has basically fled the higher-risk private-equity space. Reduced fundraising efficiency is beside the point; the crux is that you simply can't raise money at all.

According to incomplete statistics from the FOF Research Center, since the start of 2020, publicly reported dollar funds established in China have already exceeded $4.3 billion in scale (equivalent to ¥30.1 billion).

CMC: closed a third dollar fund of more than $950 million, oversubscribed by $150 million;
Yuanjing Capital: completed the first close of its $450 million third fund;
Hillhouse Capital: completed its first dollar fund raise, totaling more than ¥300 million;
Qiming Venture Partners: completed the raise of its seventh dollar fund, sized at $1.1 billion;
Lightspeed China: completed the raise of its $1.5 billion global select fund.
...

And the extra-large and large dollar funds set up in Europe and America to buy the dip are more numerous still. It's as if there's simply no sign of RMB funds at all—and even where there are, they can't make much of a splash, most of them pitifully small in scale.

According to the FOF Research Center's incomplete statistics of publicly reported fundraising events of all kinds since the start of 2020, the total scale successfully raised by RMB funds (direct investment) is only ¥16.095 billion. A gap of nearly 1x!

Even with the current tailwinds of the STAR Market and the registration-based system, they've failed to reverse the avalanche-like decline on the fundraising side. As the "incubators" of small and medium-sized tech enterprises, the weakness of RMB funds will bring great harm to China's independent tech innovation and to the development of innovative, entrepreneurial small and medium enterprises.

According to public data, as of the end of November 2019, the primary market completed the raise of 330 funds in total; among the top 34 funds, 25 were RMB funds raising ¥413.37 billion combined, and 9 were dollar funds raising $188.2 billion combined. Compared with 2018, dollar-fund raises rose 874%, and RMB-fund raises rose 28%.

Now and in the future, this trend will grow ever more pronounced: an RMB fund, however long it's been around and however good its track record, will not find it easy to raise dollars. But conversely, a dollar fund, old-line or new, has a very easy time raising RMB. It's simply heaven and earth.

The logic is easy to grasp: the market votes with its feet, and so do entrepreneurs. In team composition, operating style, thinking, compensation, LP structure, investment strategy, and exit, RMB and dollar funds cannot be mentioned in the same breath. The dollar fund's advantages are plainly obvious—the truly high-return projects are still in overseas markets, and entrepreneurs and talent alike aspire upward, choosing the better fund. RMB fund management teams have to rebuild a whole logic and playbook from scratch. But the dollar's first-mover advantage has already planted itself firmly.

"If you don't run a dollar fund, you don't eat—and that's become even more obvious over the past two years." At Hongtai Fund's annual meeting late last November, founder Sheng Xitai said this to the Hongtai employees and LPs present.

Every crisis is an act of elimination and rebirth, and China's private-equity industry is no exception. In the 2008 financial crisis, the near-collective collapse of the big investment banks is the best-known story; but what many overlooked is that in the same period, roughly a quarter of all private-equity firms in the US crashed and fell in the crisis.

Ultimately, America's fund-of-funds and LPs are very stable and can support a fund across a dozen-plus fund cycles or even longer; but China's fund-of-funds and LPs are unstable, causing the funds enormous trouble. Though it's been shouted about for years—where is China's true "patient capital"?

06 A Firm's Most Precious Asset Is Talent; Its Greatest Challenge Is Keeping That Talent Forever

Finally, one more small factor: people.

In Silicon Valley's venture circle, generational handovers and the friction they bring happen from time to time. First there was KPCB veteran Mary Meeker, who left over strategy and stage to found Bond Capital; then Ravi Viswanathan of New Enterprise Associates, who took the old shares of eight companies and struck out on his own to found NewView Capital.

Every departure and loss of core talent inflicts damage on a fund, tangible and intangible—and always enormous.

Sequoia, meanwhile, has consistently maintained the stability of its mid-to-senior ranks; only one of its partners was an outside hire, and he didn't last long.

As long as the people are there, the competitiveness and the feel are there.

07 The "Yale War" Is Poised to Erupt

Fifteen years ago, Neil Shen and Zhang Lei—one a serial founder who'd taken two companies public, the other an investor in the lineage of David Swensen; return the clock to 2005, and the two, without prior agreement, both began their investing careers in China, founding Sequoia Capital and Hillhouse Capital respectively. At the time, one did mainly VC and growth, the other mainly PE and secondary-market investing.

At the 2014 Yabuli Forum, Zhang Lei said: Hillhouse is different from Sequoia—first of all, the asset classes differ. Sequoia focuses on the VC and PE stages, while Hillhouse has been an evergreen fund from its founding, and the hallmark of an evergreen fund is late-stage, concentrated investing. "We don't overlap with Sequoia all that much; we invest in their early-stage projects too, and it's more a matter of exchange and cooperation."

At the time, Zhang Lei said: "Growth investing doesn't suit us."

Come 2015, in what's no more than the blink of an eye, Sequoia and Hillhouse were no longer the two "young men" of years past. Just recently, Hillhouse Capital launched its own Hillhouse Venture. It has now transformed into a firm that spans both primary and secondary markets and covers early-stage, VC, PE, and buyout stages alike—with more and more chances to go head-to-head with Sequoia Capital.

Finally

To sum up, Sequoia's formidability and success come down to this:

1. The opportunity of the era and the fortunes of the nation are the backdrop.
2. Brand advantage lets them avoid the misses—entrepreneurs are willing to let them invest.
3. Enormous capital scale means they can afford to invest and can get in.
4. Finally, the partners' deep understanding of and keen nose for the TMT track over these 15 years.

None of it can be missing—it cannot be replicated, and it is hard to surpass.

References

• In-Depth Observation: The FOF-ization of Front-Line GPs Like Sequoia, IDG, and Shenzhen Capital Group
• Coatue's TMT Investment Philosophy
• Bill Gurley and Benchmark's New Fund