Douglas Leone: Five Lessons On Starting a Business in Silicon Valley

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Douglas Leone at Stanford GSB | Natalie White

What does it take to successfully pitch a business concept to Douglas Leone, a managing partner at Sequoia Capital? If you want to walk away with seed money, start out by being on time, turn your mobile phone off (setting it to vibrate does not count), and don’t waste his time by displaying ignorance of your target market, he recently told a group of Stanford Graduate School of Business students.

It won’t hurt to mention that you come from a humble background, because Leone does too. His working-class family emigrated from Italy when he was 11, and his first job involved cleaning toilets. Didn’t get into your school of choice? Neither did Leone. Stanford Graduate School of Business rejected him twice, and he likes to hire “people mostly from modest means, people that have not followed a preset set of tracks.”

Sequoia Capital was an early backer of WhatsApp, investing about $68 million in a startup that eventually sold to Facebook for $16 billion. But sky-high valuations trouble Leone, who says that some — but hardly all — Silicon Valley startups “are not worth anywhere near what the private market is ascribing to them.” Here are five lessons he’s learned during his four decades in the technology industry, and which he shared during a View From the Top talk at Stanford GSB in early November.

What Not to Say at a Pitch Meeting.

Entrepreneurs often come into a meeting and say things like: “It’s a hot market” or “It’s a big market. All we’ve got to get is 3% and we’re going to be a big company.” That’s a mistake, says Leone. “Markets don’t work that way. Winners take 70%.” Don’t bring a presentation that includes 23 slides on the product and just two on the market, he says.

“Crystal clear thinking is one of the things we look for — not a fancy slide pitch, but crystal clear thinking,” Leone says. He looks for entrepreneurs who understand that running a company is a team effort. That means he pays careful attention to little words, listening for “we” instead of “I”: “When someone says, ‘I can ship you this thing,’ it’s a little warning flag.’’

Develop Products That Solve Real Problems.

Consider that the founder of Zappos started his company because he couldn’t find a pair of shoes, Leone says. Entrepreneurs who see a problem they have experienced and set out to make a product that solves it for millions of other people are those Leone is more likely to bet on. “Jan [Koum] of WhatsApp understood privacy and low-cost messaging. He had that need. He started WhatsApp. Or the founders of Yahoo from Stanford couldn’t find anything on the Internet, so they built a search engine — they built a Yellow Pages.”

Don’t Raise Too Much Capital.

It’s tempting to raise a lot of capital early on, but that has a downside: giving up too much equity, Leone says. “Raise as little as you can to get you to something that you can show — plus maybe a quarter or two so you have a little bit of cushion — and then raise some more money. Raise as little — not as much — as you can because that’s the most expensive equity you’re going to sell,” he says, referring to early-round funding.

“Guard those shares [of equity in your company] with your life, and you should architect your investors the same way you architect your product and your engineering team,” says Leone. “And, conversely, be very generous with the early engineers that you hire. Those are the ones that you should invest in, because the first two or three engineers, if you get those wrong, you are done,” he says.

Not All Founders Are Created Equal.

Deciding to share equity equally among a group of founders is a common mistake, because in most cases, their contributions to the startup are not equal, says Leone. This “socialist sense of equity” may lead to a fast blowup.

In some situations, he says, one person might write all the code, and two of the other founders don’t do as much. Still, “they have this notion, ‘We should split things three ways.’ No, you shouldn’t split things three ways.”

“We Live in Cycles.”

Not long ago, a billion-dollar valuation for a new company was almost unheard of. Now it’s routine, and that raises the possibility that the market is nearing the peak of an investing cycle in tech. “Every time you hear ‘it’s different this time, it’s the first time this is going to happen,’ that’s all crap. We live in cycles, and the more times you hear the words ‘billion-dollar market cap,’ the more you know you’re approaching a top of the cycle,” says Leone.

Companies with poor business models will not be able to raise money if there’s a hiccup in the public market, he says. Hedge funds will pull back, and later-stage funding will dry up. “And then it’s going to turn ugly real quickly,” says Leone.