“THE MORE MONEY YOU RAISE, THE LESS VALUE YOU CREATE”

Jim Goetz is a partner at Sequoia Capital, one of Silicon Valley’s oldest venture capital firms. He spoke with HBR about why start-ups are growing so quickly. Edited excerpts follow.

Q: WhatsApp, which you funded, was sold to Facebook for $19 billion just five years after its founding. Is that growth indicative of changes in the market?

A: WhatsApp spent almost nothing on marketing – word of mouth drove adoption. And today start-ups have the App Store and Google Play, which allow them to touch three billion consumers. For the first time in the mobile ecosystem, you can reach half the planet without building a distribution system.

If start-ups don’t need VC cash for marketing, should they be raising so much capital?

In our portfolio, there is a correlation between cash required and long-term market cap – but it’s negative. The more you raise, the less value you create. Google, Cisco, and Oracle were incredibly efficient with their cash, as were ServiceNow and Palo Alto Networks. Those companies all had market caps north of $10 billion within a couple of years of going public. One curse of raising lots of cash is you lose that discipline. We discourage our teams from raising too much capital.

What about Uber?

Uber may be the counterexample. Expanding globally became an expensive proposition, so its war chest makes sense. Airbnb, in which we were an early investor, has also raised more capital than its cash flow statements and P&Ls suggest is needed, but for a different reason. Raising capital is attractive right now, and the company views it as insurance, not as something needed for operations.

Are we in a bubble?

We don’t think so; we think private company valuations of some so-called unicorns have been inflated by the way latestage investments were structured. In many cases investors are protected from much of the downside by terms that make the deal look more like debt than equity. If investors were unable to get those terms, they probably wouldn’t value some of the unicorns as highly. A handful or more of these companies may end up with Facebook-like valuations 10 years from now. But several dozen more will disappear.