"To be the best, learn from the best."
#57
Longish post.
I’m a big fan of learning from the best. Or in any case, the top 20. Which is why I really like #53, where I have some notes from Arnuj Abrol’s deconstruction the investing methods of the top 20 early stage VCs worldwide. For reference, these top 20 firms (~3% of total), make 95% of all venture returns. (!!!!!) These numbers are wild and as a LP, I’m not sure why I would not spread whatever money I have across these GPs and just let them ride. 🤷🏾♂🤷🏾♂
Sequoia is one of the best VCs in the game. I study them and learn as much as possible from reading on Don Valentine and listening to stories about them on podcasts like Acquired and watching Don talk at Stanford GSB. I study them and make mental models based on how a firm like that was built. I found Sequoia’s investment memo written by Roelof Botha (Partner at Sequoia) when he recommended they invest in YouTube. (It’s the only public one) and now it’s a model for how I write my investment memos for companies I think have potential. This is the preamble. Enjoy.
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Introduction
YouTube represents an interesting seed-stage investment opportunity. The company’s goal is to become the primary outlet of user-generated video content on the Internet, and to allow anyone to upload, share and browse this content.
The three entrepreneurs are scrappy and smart. They have built a very easy-to-use, fast growing service that tops several strong veins: user-generated content, online advertising, wide proliferation of inexpensive digital video capture devices, and continued broadband adoption.
The company has also developed code snippets that allow users to embed YouTube videos directly into other sites. In this way, the company is building a wide content distribution network, in addition to its direct-to-site traffic.
Deal
Our proposal is to invest $1m in the seed stage, followed by a $14m Series A once specific milestones are met. Sequoia will own ~30% post Series A, with a pool of ~17%.
Competition
There are several direct and potential competitors to YouTube. These include:
Direct competitors (dailymotion, vimeo)
Community photo sites (flickr, webshots)
Online photo sharing sites (ofoto, shutterfly, snapfish)
Large internet players (Google & Yahoo video search)
Entertainment sites (big-boys, ebaumsworld)
File sharing services (ourmedia.org, putfile)
IPTV companies (Open Media Network, Brightcove)
YouTube appears to have a clear lead over its two direct start-up competitors. The other categories of potential competitors are not necessarily focused on video content, or are not focused on user-generated content within the context of a community-based site. Nevertheless, the company will need to stay very focused over the next 3-6months to ensure that it builds a rich set of features and content depth to increase its defensibility.
Hiring Plan
We need to help the company quickly hire a CEO and VP BD/Sales. The founding team is enthusiastic about bringing an experienced CEO to help lead the company. However, I am not sure whether we can land a CEO before the Series A. I would appreciate any ideas on potential candidates for either role. My preference would be to launch a search immediately and to have a CEO in place within 90 days.
Two additional PayPal engineers are set to join in the next week. Both are exceptional.
The plan is to house the company in our incubation area for the near term. That will help us frequently interact with the team until we can surround the company with an experienced management team.
Key Risks
Competition/Defensibility
As outlined above, YouTube faces significant potential competition. The company needs to remain laser focused on improving the user experience to ensure that it continues its early growth trajectory.
Revenue Model
I believe that YouTube has a clear advertising opportunity. However, we don’t yet know what form of advertising would work best. Specifically, can the company develop attractive ad products that are not intrusive to the consumer experience? We can model revenue as follows: # unique videos streamed per day x % of videos monetized x CPM x 365 = estimated annual revenue. Several of the parameters are unknown:
We don’t know what CPM rates YouTube could command. Video and CPMs could range from a low of $5 to over $30.
We don’t know what percentage of inventory (videos served) could be monetized.
We are not sure how much YouTube could grow from its current level of 100,000 videos served per day.
Below are different scenarios and their associated revenue potential:
Videos served/day CPM % of videos monetized Implied annual revenue
Scenario 1 10 million $10 15% $6m
Scenario 2 20 million $15 20% $22m
Scenario 3 30 million $20 25% $55m
**CPM = cost per one thousand views
We will test these assumptions carefully over the next few months to get an accurate handle on the company’s revenue potential. We also need to test the success of the company’s content distribution network, and whether we can generate advertising revenue from this network. (Google earns ~55% of its revenue from Google-owned sites, and 45% from Network websites.)
Serving 10-30 million videos may appear daunting, as it represents >100x increase over the company’s current activity levels. But the company has achieved its current scale in only two months, and only 15,000 videos today. (for point of comparison, Flickr and Webshots, two comparable photo community sites, serve 200-500x as many page views per day as YouTube.)
Scalability
As the table above indicates, YouTube will need to scale significantly from its current level for the company to achieve meaningful revenue. We need to ensure that YouTube can inexpensively scale orders of magnitude from current levels.
Balancing Growth
YouTube has already drawn the attention of larger media companies (e.g. Turner, Transcosmos) that see the potential of distributing YouTube content. As with any marketplace, we need to ensure the balance of demand and supply. It would be inadvisable to grow the viewer base significantly without a substantial increase in the number of videos available on the site. The company cannot afford to disappoint customers due to inadequate depth of content.
Exit
We cannot point to many high comparable exit valuations.
A few comparable companies include Webshots Flickr, Ofoto, Shutterfly, and Snapfish. While these companies deal with still images, there are some similarities with YouTube. None of these companies have had exceptional exits. CNET bought Webshots for ~$70m, Yahoo! bought Flickr for < $50m. Apparently Shutterfly is preparing to file its IPO, Ofoto and Snapfish were acquired by Kodak and HP, respectively, although financial terms were not discussed.
Another comparable is Blogger, acquired by Google in 2002 for an undisclosed amount.
There are other examples of businesses that built successful models leveraging user-generated content, including TripAdvisor, acquired by IAC in 2004 years ago for over $100m (to the best of my knowledge).
Recommendation
I first met with the company three weeks ago, and we are in pole position for the financing. Several VCs have been cold calling the company, and a few media companies have also approached YouTube. I’d like to give the company our decision on Monday.
I recommend that we proceed with the financing as proposed.
YouTube has a great founding team that has hit on several promising themes. The company follows a trend of user-generated content that started with text (blogs), images (Flickr, webshots, Ofoto), and audio (podcasting). Video is a natural next step, and YouTube is well positioned to capture the lead. The company has not yet enabled advertising revenue streams. But our checks with Yahoo! and Adbrite indicated very strong advertiser demand for online video advertising. We will rapidly need to surround the company with management talent, specifically a CEO.
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I have my notes from reading this memo on what’s important to include in such. I’d post them and my learnings as I write out more memos and see how they play out.
Happy Sunday.
📱📱Quote of the day
“I am 100% behind my CEOs right up till the day I fire them.” - Don Valentine
Remember folks: “Until the lion learns to write, every story will glorify the hunter.”