A Conversation with Shen Nanpeng, Part 2: Markets, Founders, Long-Term Thinking, and Smart Money

A conversation with Sequoia China’s Shen Nanpeng—2 He Zhenhong: ByteDance’s TikTok is now facing a major challenge, too. (The Trump administration in the United States is demanding a breakup.) Shen Nanpeng: Going international brings more challenges. Having a team with an international outlook is crucial preparation. And in any overseas market, you will face intense competition from local rivals. ---- This section discusses investment and mergers. On an era dominated by leading companies: every merger has clear commercial logic behind it. He Zhenhong: Since last year, we have begun to notice an era in which leading companies dominate. In mature industries, the leaders hold resources, set rules, and build ecosystems. This new generation of companies is doing the same. What should midsize and small companies do? Shen Nanpeng: Industries still differ. In the new economy, particularly the internet, one fairly clear characteristic is winner-take-all competition. There may be only two companies in food delivery. In e-commerce, perhaps only four or five will ultimately survive, develop healthily, and reach considerable scale. In the traditional economy, industry consolidation and concentration among leading companies used to happen relatively slowly. In fact, concentrating social resources in stronger businesses can improve efficiency. The same is true in the United States and Europe: some consolidation happens through mergers and acquisitions rather than the elimination of small companies. He Zhenhong: Once China’s leading companies become firmly established, we may also see alliances among giants. Shen Nanpeng: The media often ask what role we played when portfolio company A merged with company B. We are happy to play that “adviser” role, but every merger actually has very clear commercial logic behind it. Entrepreneurs are smart. If 1+1=0.5, absolutely no one will do it; if 1+1=3, entrepreneurs will consider it; if 1+1=5, everyone will certainly be eager to explore it. He Zhenhong: Someone has to see that logic, or be able to explain it clearly enough for both sides to accept it. Shen Nanpeng: Exactly. That is the role we should play. Sometimes we are shareholders in both companies, sometimes in one. We take a longer-term perspective and a broader view to help entrepreneurs see the advantages and disadvantages of consolidation. He Zhenhong: Ultimately, one side always has to step aside, because a company can have only one leader. I wonder whether the person stepping aside feels good about it, too. Shen Nanpeng: It depends. For example, after 58.com and Ganji merged, having only one CEO for a business entity did make arrangements difficult. But Yang Haoyong quickly found a vertical segment within the merged platform—automobiles. He spun that business off into what is now Guazi Used Cars. Some entrepreneurs’ next dream is to start another company; others become investors. These are different choices. ---- On investment philosophy: long-term thinking depends on “smart money.” He Zhenhong: Among so many investment candidates, how do you decide which are worth investing in? What are your criteria? Shen Nanpeng: Our criteria have not changed in 15 years. They sound simple—just three points—but in practice, each is difficult to assess. First is judging the entrepreneur. Behind every successful, great company is a distinctive, outstanding entrepreneur. Once a company is an industry giant, it is easy to make that judgment. But identifying the next Wang Xing or Zhang Yiming early on, at the seed stage or Series A, will always be an art. It is hard to quantify. Second is the size of the industry. Successful companies are highly ambitious, but the key is being in a “good” industry where the sky is the limit. We should focus on industries with enormous room to grow. When we began studying China’s e-commerce market more than a decade ago, we recognized that it would become huge. But we may not have that intuition early in every industry. Seven or eight years ago, for example, if you had asked me how big food delivery in China would be—100 million orders a day or 50 million—I really could not have said. Some industries evolve rapidly, so imagination and forward thinking are necessary. Third is still the business model. Some models naturally create competitive barriers, quickly shutting out later entrants and successfully gaining a larger market share. Others are prone to commoditization. Traditional manufacturing, for example, is often characterized by relatively low technological barriers: if you can ramp up volume, so can I, and competition ultimately comes down to price. He Zhenhong: Businesses have to leave their comfort zones to move forward. Would you invest in companies doing that? Shen Nanpeng: What matters is whether the business has the determination and resources for change. We have spoken with many such “traditional” businesses. If they want to transform, do they have a new group of team members? That is very important. I am not saying traditional CEOs are incapable, but you do need a new team to help you move up the market learning curve more quickly. What is the biggest challenge in information technology? A market that changes from moment to moment. I believe these entrepreneurs have strong learning abilities, but sometimes learning costs too much. Can they recruit talent to close their gaps quickly? Li Jianquan of Winner Medical is a good example. He might belong to what we call the “previous generation” of entrepreneurs. His company had operated for nearly 30 years, mainly in medical dressings. But he thought of applying medical technology to new consumer products and launched Purcotton, relying primarily on internet marketing to open up new territory in the industry. He keeps learning, is very patient, and can attract the best young people to his team. Today, Winner Medical has successfully expanded into an important player in consumer products. --- He Zhenhong: What do you require of people? For instance, what kind of person would you refuse to invest in? Shen Nanpeng: First, they must respect the rules of business. That is our most basic requirement for entrepreneurs: they cannot be looking for ways to skirt the rules. Another important criterion is whether the entrepreneur is focused on short-term gains. Financing is much easier now than 10 or 15 years ago. Some entrepreneurs feel they can quickly sell a business or list it and cash out for a large financial reward. So we need to understand why they are building the business. Entrepreneurs really do differ in their attitudes toward this. He Zhenhong: Some say Sequoia Capital’s philosophy is to invest in the track rather than the racer. Shen Nanpeng: That is a major misconception. We pay attention to both the track and the racer, and the racer should come first. However good the track, if the racer is not up to it, even a temporary lead will be hard to sustain. We have invested in some founders before they had finalized what they would do. They could outline a broad industry direction but had not worked out the specific product or service. I think that is fine. In our industry, we call it a “blind bet.” You believe in their values, ability, and previous performance, and care less about the precise niche they enter. Usually, some time after we invest, they work out which track fits them best. He Zhenhong: Some say long-term thinking is a compass through the fog of cycles, helping entrepreneurs create value continuously. How do you understand it? Shen Nanpeng: Long-term thinking is easy to talk about but hard to practice. Here are a few things I have learned. First, its other side is the ability to resist short-term temptations. Human nature often draws us toward short-term benefits. Many industries are hot today, and indiscriminate investing can still make money in the short run. Do you do it? Choosing what to do and what not to do matters greatly for investors and entrepreneurs alike. Second, intellectual honesty matters, but “honesty” comes first: honestly facing the successes and failures of your investments. You tend to favor businesses you have already backed and overlook negative information. Some information often conflicts with your intuitive impression. As an investor, it is crucial to be grounded in facts and not mislead entrepreneurs. Once misleading people becomes a habit, you eventually mislead yourself. Also, investment decisions based on facts and data can produce better analysis. That rational analysis can help you maintain a long-term perspective. He Zhenhong: Both are difficult: resisting quick money and being factual and intellectually honest. You might originally have expected a 50-fold return, only to find it will be 10-fold or just twofold. Shen Nanpeng: Investing requires overcoming some tendencies of human nature. For example, if you misjudged a company at Series A, do you have the courage to approach it again a few months later? You may receive a cold reception, and its valuation may have risen substantially. Can you face your earlier mistake? Have the courage to acknowledge errors and understand the business with a fresh mind. --- He Zhenhong: Does Sequoia hope to become a mega-fund, something like Vision Fund? Shen Nanpeng: Over the past decade or so, Sequoia globally, including Sequoia China, has substantially increased its fund size. First, we are not trying to be a small boutique, but neither are we trying to maximize scale. We first ask whether the assets we manage allow us to achieve our investment goals and provide enough resources to help entrepreneurs. Second, and very importantly, a fund should be judged not by the size of its assets under management (AUM), but by the returns it delivers to investors. Fund life may matter more. Why do we still hold Meituan shares after so long? First, we believe in the company. Second, our funds give us the flexibility to act on that conviction. We want entrepreneurs to think long term so that investors can practice long-term thinking, too. If your capital is available for only seven or eight years, how can you do that? He Zhenhong: Only a fund that consistently ranks among the leaders has the ability to practice long-term thinking? Shen Nanpeng: Yes. If you consistently deliver leading returns, your limited partners (LPs) can place a high degree of trust in you, allowing you to take that long view. Nor do we believe in “supporting” companies by throwing money at them. Instead, we should be the market’s smart money, helping businesses at critical moments. As a company develops, from Series A to Series B to listing, and even afterward, Sequoia can continue supporting it. Our almost evergreen fund-life structure lets us accompany businesses for a very, very long time. ~To be continued #中國企業家202010 (Chinese Entrepreneur, October 2020)