It is very hard to get genuine transparency on what VCs look for when making an investment. Some investors share their investment criteria, but rarely how they have assessed opportunities against those criteria.
The only public domain investment memo I have found is by Roelof Botha recommending that Sequoia make a seed investment in Youtube1. Roelof has supported some of the most exceptional companies over the past decade including Youtube (I think one of his first), Instagram, Tumblr, Evernote, Square, MongoDB and others. It is a rare opportunity to see how such an accomplished investor thought about the opportunity behind closed doors and communicated his thoughts to the partnership.
In 3 succinct paragraphs Roelof articulates his primary theses that underpin why he thinks YouTube is a compelling opportunity. The most fundamental of these is his hypothesis that Youtube can become the ‘primary outlet of user-generated video content.’ This is supported by calling out several ‘strong veins’ (macro trends) that Youtube taps into2.
Roelof lets his simple thesis and supporting macro trends stand for themselves. He doesn’t feel the need to defend these foundational premises or articulate them further to the partnership. This concise thesis, articulated in 9 lines, seems obvious in hindsight but at the time video was basically non-existent on the web.
Roelof lays out the shell of an investment in a single sentence: $1M followed by a $4M Series A for ~30% of the company post Series A. It is interesting that Sequoia intended to traunch the investment contingent on the company achieving 5 ‘specific milestones’ spanning business planning, product, customer acquisition, and hiring.
Assuming Sequoia maintained ~30% ownership in the company through the Series B, Roelof returned ~$480M on a cumulate investment of <$10M between writing this memo on September 2nd, 2005 and the sale to Google on October 9th, 2006 for $1.6B.
Roelof indicates his position on the company’s top priority over the next 3-6 months: focusing on product development to ‘increase [YouTube’s] defensibility.’ This would likely have translated into his key priority when he joined the board. Documenting this in the memo can be valuable in solidify the investor’s perspective, and also to ensure the investor’s perspective is aligned with the founders and his partnership at the time of the investment.
Roelof also calls out finding executive talent to support the founders as an area for the partnership to help: ‘I would appreciate any ideas on potential candidates for either role.’ He also hints at management as an item for discussion as a team: ‘My preference would be to launch a search immediately.’ In this way, Roelof keys up conversation for the Monday meeting, and turns the memo from being an essay of personal thoughts to a collective document detailing the partnership’s priorities.
This is the longest section of the memo, comprising 50% of the 3 pages. This section could also be titled monetization, as Roelof primarily assesses if YouTube could reach the scale to generate meaningful ad revenue. Roelof breaks out the key risks across the following 5 subcategories, almost all of which are relevant when thinking about any opportunity:
- Competition and Defensibility
- Revenue Model
- Balancing Growth
Roelof again makes it clear that defensibility should be the primary focus: ‘The company needs to remain laser focused on improving the user experience …’
The ‘Revenue Model’ section is the only place in the memo when Roelof uses the word ‘believe’: ‘I believe that YouTube has a clear advertising revenue opportunity.’
He makes it clear to the partnership that the revenue model is still unclear and raises questions for the rest of the partnership to consider, again, teeing up topics for discussion on Monday: ‘can the company develop attractive products that are not intrusive to the consumer experience?’
In the rest of the ‘Revenue Model’ section Roelof lays out 3 different bottom up market sizings based on the 4 key revenue levers in sees in the business3. Roelof notes that he intends to make sure the company carefully tests these levers over the coming months. Again, Roelof’s investment memo for the team likely translated closely into his key priorities for the board post-investment.
In the ‘Exit’ section Roelof succinctly states that: ‘we cannot point to many high comparable exit valuations.’ Unknown exit opportunities doesn’t deter him from recommending an investment though, nor does he feel the need to further articulate his thesis.
Roelof updates his partnership on how Sequoia is positioned relative to other VCs (‘pole position’). Despite being pole position, Roelof doesn’t want to wait around the hoop.
He tells the partnership he would ‘like to give the company our decision on Monday.’ The memo is dated September 2nd, 2005, which was a Friday, so the partnership likely had the weekend to review the memo.
In the last paragraph Roelof clearly lays out why he recommends an investment:
- Great team
- The growth of user-generated content with video as the next step
- Early indication of video ad potential based on diligence
Abstracting a level higher we can group these under: management, market, and monetization.
It is easy for VCs to operate in silos, but throughout the memo Roelof emphasizes Sequoia’s collective role in evaluating the opportunity and supporting the company by using ‘we.’ In this section, when articulating his final perspective based on the analysis, Roelof switches to the first person subjective: ‘I recommend that we proceed with the financing as proposed.’
He ends by reiterating the team’s immediate focuses post investment: ‘we need to surround the company with management talent’4.
It’s particularly interesting that through the memorandum Roelof doesn’t appear to try and sell the opportunity to the partnership. The memo doesn’t have a section titled ‘upside’ or ‘opportunity,’ and he clearly calls out what he doesn’t know. Between the section on key risks and competition, over 50% of the memo focuses on discussing areas of concerns. The team likely already agreed on the macro trends that could support a mass market UGC video platform, which allowed them to focus their diligence and debate on whether or not YouTube could monetize and if management was the team to build the product.
These are user-generated content, online advertising, proliferation of inexpensive digital video capture devices, and continued broadband adoption. ↩
It’s funny to play monday morning quarterback and think about how wildly small Roelof’s bull case of 30M video views per day was given that YouTube passed 4B in January 2012. ↩
The memo has the following backup material: 1) Investment summary 2) Competitive analysis 3) Technology overview 4) Team bios 5) Company presentation 6) Company metrics. The investment summary seems to be a 1 page document written in advance of the full investment memorandum. The document is likely an early set of bullet points on the opportunity so the rest of the team knows about the company early in the diligence process. The investment summary may also be a consistent framework that the teams uses to analyze any opportunity and provide rigor. In the supporting materials on ‘Competition,’ Roelof walks through each of the subcategories listed in the memo in more depth, including any public traction and exits. The remaining 4 sections of additional content are information provided by the team. ↩