Rajan Anandan on what Sequoia Capital is looking for in startups

What to look for in start-ups and what is the goal while backing startups
The goal is to build enduring companies, companies that 10 or 15 or 20 years from now are going to make a dramatic impact on the industry that they are in or the world at large. They are going to generate extraordinary amounts of free cash flow and so at the end of the day, that is the goal. The most important thing is to build products that consumers love. So we have this term at Sequoia that we call user love, do your customers – be they consumers or businesses– absolutely love your product because if they love your product, they will pay you for it, they will pay you more than what it cost for you to make.

That is one of the challenges we have had in some of our transaction based, commerce based businesses where products were being sold for less than their cost. One cannot really build an enduring company on that.

Secondly, they will keep buying it – be it a consumer or a business. But beyond that, you got to have what we call economically viable growth. A start-up that is profitable but not growing is “default alive” using YC terminology but is not that interesting because to me from a start-up you have to eventually become an enduring company which means you need to grow but you got to grow prudently and the way we think about it is unit economics.

So we look at unit economics and say your gross margins have to be very strong, contribution margin after marketing should be positive. Today if the contribution margin in a start-up is negative, that is not a good place to be. You have to have a positive contribution margin and that is called high quality growth. So what we are really looking for is very strong consumer love combined with high quality growth and high quality meaning the math works; you can look at your business and say whether the math works or not. If the math does not work, then you got to go fix the math.

The other thing I wanted to ask you is we are talking about gloom and doom. It is not just about mark downs, it is scary times to be an employee of a start-up because just look at the kind of mass layoffs that we are seeing. If you are going to build an enduring company, you cannot build it without a workforce. And these are seriously well funded start-ups.
Well funded, well run companies. These are companies that we all admire. Look what happens is in periods like the second half of 2020 and 2021, there was an extraordinary amount of capital. The Indian start-up annual funding went from $10 billion in 2020 to $45 billion in 2021, that is four-and-a-half times growth. Obviously the leading companies raise large amounts of capital and sometimes you do end up growing faster, you do end up hiring lots and lots of folks because you think this could continue forever and then the markets change and then you are faced with new reality and some of these companies have taken action to get their cost structure in place.

At the end of the day, the math to work has to work and companies sometimes have to take the action and it is very difficult for employees but it is also very difficult for founders and management teams. Remember before Sequoia I was an operating leader for a long period of time and I have taken in my career, several of these actions and I can tell you it is very difficult to do but at the same time you get to a point where it is better to do it, if you are going to do it it is better to do it early than later because later when you do it, you may not be able to save the company as well.

It is very difficult as we are going through this period but it is important to keep in mind that there will be these cycles. We are in 2022. In 2030, this ecosystem is going to be 10 to 20 times bigger but we still have cycles and maybe sometime in the next decade, we are going to look back and say 2021 was exuberant, but boy this is even more exuberant! These things happen, these cycles happen and this is how the global economy evolves.