A Conversation with Greylock's Reid Hoffman and David Sze [Full Video]

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Screw You, Benioff

Following the two teasers from earlier, here’s the full video from when Reid Hoffman and David Sze of Greylock stopped by the TechCrunch offices last week to answer Mike Arrington’s questions about valuations, the state of venture capital, and their portfolio companies.

They wriggled out of many of the detail-oriented questions like when companies like Zynga, Facebook and LinkedIn would go public and how much revenue they’re each bringing in. But we still got some great gems from two of the best investors in the consumer Internet. It’s required watching if you plan on pitching Greylock or any top investor anytime soon.

Transcript…

Mr. MICHAEL ARRINGTON: This is Mike Arrington. I’m with David Sze and Reid Hoffman from Greylock Partners. Welcome guys.

Mr. REID HOFFMAN (Greylock Partners): Thank you.

Mr. DAVID SZE (Greylock Partners): Thank you.

Mr. ARRINGTON: David, you joined the firm in 2000 and you led investments in Facebook, LinkedIn, Vudu which was sold to Walmart for how much?

Mr. SZE: The magic price of undisclosed.

Mr. ARRINGTON: Will get to that later. Revision3, Digg, Oodle, Pandora and Social Gaming Network – SGN . Reid, you have only been with Greylock since… eight months now?

Mr. HOFFMAN: November last year.

Mr. ARRINGTON: So, less than that, end of 2009. You are the co-founder of LinkedIn. You’re also on the board of Zynga, Mozilla, Six Apart, Shop Kick and Kiva.org. And you have investments in Digg, Gowalla, Facebook, Flickr, Last.fm, Ning, Six Apart and Zynga. Did I leave anything off of that you guys want to mention?

Mr. SZE: That’s complete.

Mr. ARRINGTON: Yeah. A good list of investments. Thanks for coming by our office to talk about what’s going on in VC today. So, let’s start off with an easy one, being a venture capitalist today. Do you guys agree that returns over the last few years are probably too low to justify the amount of venture capital in our system right now?

Mr. HOFFMAN: So, I think that basically the challenge is like always when you actually have a competitive field that’s valuable to be in, you have a lot of things that don’t deliver as well. So, I think there’s a lot of venture capital that isn’t delivering as well as it could. But I think there’s venture capital that can deliver spectacularly well. That was part of my decision to personally lean in because actually I think there’s interesting opportunities in the future and there’s interesting ways of driving a great venture firm to still do these continuous results. So while I think there’s a ton of capital, I think it’s a competitive field and I think a lot of it doesn’t deliver very well. I think it’s still possible to do disproportionate returns.

Mr. SZE: I also think – the economy’s cyclical, the market is cyclical, some of our new technology is cyclical as well. And so, but I think there have not been great cycles for that in the last you know, 10 years. But look at the comparison to other classes, you tell me what the asset classes are that have been doing really well on that time frame and on a relative basis I might agree but I think it’s been tough all around for the last 10 years.

Mr. ARRINGTON: Medical devices might be one. If you look at the data from the last quarter, there were 111 M&A deals, 31 of those were disclosed, the price of it – average about 180 million dollars per deal which is actually a third higher than 2009. But it still doesn’t seem like it’s very high. One of those deals was 800 million and that was Ethicon, it’s a medical devices company. So, if you take that out, it’s like YouTube really affecting that quarter when they were bought by Google, it’s not looking very good. Forgetting the IPOs, just looking on the M&A front. Do you guys see something happening with the future that’s going to help this?

Mr. SZE: Well, we don’t really invest on medical devices so, I cannot comment on that.

Mr. ARRINGTON: Yes, but I’m talking about the rest of the stuff.

Mr. SZE: Yeah, I think we’re seeing foundations for starting the companies that are survivors from that time frame and the strong companies when you invest in them and I think we have a number of them hopefully and we believe so. They are still thriving and the markets will come back and the markets will recognize that. Even in the last week, we’ve had a number of IPOs that had done quite well. We’ll see if that is a blip or a trend. But you know, the most important thing for us is investing and making companies great and then they have all the options they want whether that’s to go public or stay private.

Mr. ARRINGTON: There were 10 – I’m sorry, Reid.

Mr. HOFFMAN: All I was going to say is, we have a focus on software from the internet mobile enterprise and there are massive scales of opportunities still on those basis. So, in terms of the fact that there are may be some depressed M&A markets, and sometimes actually, I think companies take a little longer to go public but I think you know, if you look at Facebook, LinkedIn, other things, they’re building upon massive amount of momentum. So yes, they could have gone earlier but they’re actually building into a momentum, building very big companies.

Mr. SZE: To be clear by the way, the funds that are in those years, the last 5-7 years, we think those will be our be are best funds ever.

Mr. ARRINGTON: Best funds ever?

Mr. SZE: Yeah.

Mr. ARRINGTON: There were eight venture-backed IPOs last quarter, it took them an average of 10.4 years – which is increasing – to get public and 156 million venture capital. That speaks to your last comment on the people taking a little longer. One of the problems though is that some of these startups, they go public, they’re making it to the public space, they’re very thinly traded and the VCs can’t get out of them. So, it’s not even recorded for the VC to actually get out of the stock right away. So, you guys seem pretty bullish on this but all the stats suggest things aren’t looking too good. Are we counting too much on Facebook, LinkedIn, Zynga, moving us to the next level of the VC industry or the wider platform of companies?

Mr. HOFFMAN. My first thing is it, a lot of investment – both angel and venture – is about getting the blockbusters, right? So, it really matters to be in the very big ones and then you don’t have these problems of , for example, thin liquidity et cetera. There are may be some IPOs where the cycle takes longer to get out and than that’s more of a mid result as opposed to a spectacular result. But for example, when I look in my own angel portfolio, it’s like we’ll take the biggest one, factor that out, that’s half of the whole portfolio.

Mr. ARRINGTON: What’s the biggest one?

Mr. HOFFMAN: Well for me, probably LinkedIn and Facebook.

Mr. ARRINGTON: Okay LinkedIn, because you’re a founder not because you’re an angel investor.

Mr. HOFFMAN. Oh, but I also put money in the Series A.

Mr. ARRINGTON: You did? Okay. Who’s going to go public first, LinkedIn, Facebook or Zynga? You guys are investors in all three so you can obviously speak to this.

Mr. SZE: The great news for us is you know, if you look at most people’s list of the top five candidates to go public, we’ve got three of them. And if you want to include Reid’s board on Zynga, I think we may have four of them. So you know.

Mr. ARRINGTON: What’s the fourth one? Facebook, Zynga, LinkedIn?

Mr. SZE: And Pandora.

Mr. ARRINGTON: Oh, so Pandora’s… you’re looking at Pandora for an IPO now. Last summer, they said they’re going out of business.

Mr. SZE: Any of these companies are the kind of businesses that are doing incredibly well at a scale where they have all kinds of opportunities for them. That doesn’t mean they will, that doesn’t mean they should. Those kind of companies, you also – when you’ve get to that kind of a company, you also want to be incredibly careful because it’s a precious thing. And there are wonderful things to be involved. We’re very excited and honored to be involved with those entrepreneurs. But, you know, whether they go and decide to do that or not, not something for us to comment on, but once you get there, you have all kinds of options.

Mr. ARRINGTON: So, which one goes public first?

Mr. HOFFMAN: Unfortunately, being on the LinkedIn board and the Zynga board, it’s something I have knowledge about, so, I cannot comment on.

Mr. ARRINGTON: Zynga recently announced, not announced, but said that they’re doing about three million a day in revenues sometimes, that’s amazing. How are they doing that?

Mr. HOFFMAN: Zynga is doing very well, I can’t comment on that, how much.

Mr. ARRINGTON: They didn’t actually say that. I just figured it out. Okay. The topic I really want to talk about to you guys, you said you didn’t want to talk about so much but I want to at least bring it up, consumer internet valuations which have gone absolutely crazy in the last few weeks which means Quora estimated by us to be closing in the 86 million range valuation, FourSquare around 80, Blippy 38 million. What’s going on? Is this just being driven from the Facebook and Zynga valuations in the previous year or is it highly competitive situation with VCs? What’s driving this?

Mr. SZE: You know, first of all, let’s say – Reid can comment also – it’s hard for us to comment on other people’s valuations we’ve been told we’re insane to invest in Facebook when it was, you know, 12 million user, a closed network in colleges. I was told that was a too – every deal I’ve done, I was told that it was too expensive. So only time will tell. We can only account for the ones that we decide what price we should pay for. Those prices you do have to talk to those folks for. And I do think it is true that and we believe that we have seen – if you hit the right companies, what you paid to get in doesn’t really matter. The question is, do you know it’s the right company to start with.

Mr. ARRINGTON: So, if it’s the right company, it doesn’t matter what you pay.

Mr. SZE: But you can’t know that, right?

Mr. HOFFMAN: Well and also, part of what you’re doing is, I mean actually I think that the real thing of valuations is not so much — because consumer internet can grow with low capital to very big results. That kind of thing makes it actually – is what makes it an interesting investment opportunity. So, you say, okay, well, it looks like a high valuation, but can still get to a very high result and that still makes it a potentially good investment. The real trick on valuations I think is aligning interest between essentially investors and the company so that they’re aligned over a range of exits. So, the driving – just driving the valuation up is I think frequently not that good an idea for the company because you actually want to be aligned in each of the exits.

Mr. ARRINGTON: We used to hear that all the time. But you actually don’t want a valuation was too high for various reasons. Mostly because you want to be able to do further rounds. You want to be able keep your company attractive to investors. We’re not saying that at least with the hottest deals – you’ve seen these guys, you know, go for the gold here and…

Mr. SZE: Only time will tell. You don’t know that, right?

Mr. ARRINGTON: Only time will tell if these deals are successful. Yeah. But I guess the question is…

Mr. SZE: Even more, only time will tell at the next round whether it turns out that that valuation…

Mr. HOFFMAN: Yeah.

Mr. SZE: And, you know, the degrees of freedom go way down.

Mr. ARRINGTON: Yeah.

Mr. DAVID SZE: And so, I think that these things end up there being very much a Goldilocks factor and I think people have to be as concerned about getting too far one way than the other.

Mr. ARRINGTON: Yeah.

Mr. HOFFMAN: And you want to plan for the entire length and history of the company.

Mr. ARRINGTON: Yeah.

Mr. HOFFMAN: But that’s part of what’s keeping it – that doesn’t mean low valuation. It just means think about aligning interests across the whole range.

Mr. ARRINGTON: OK. Fair enough. All right. Let’s talk about something I think you guys do want to talk about which is trends going forward. How excited are you about social networking and gaming in terms of revenue generation? I mea are they going to have a Google moment and find a way to create massive amounts of revenue and be public companies with huge valuations.

MR. HOFFMAN: So I think it’s already proven across all of the – essentially – market leading companies. I think, you know, Facebook, Zynga, LinkedIn, you know, basically all have perfectly great streams. I can’t comment on the numbers – I know that’s the next question – but all of them are doing quite well and so – I think as categories they’re proven, the interesting question will be how many additional companies within those categories, how broad is each category, are there additional categories as well. Those were the things, I think, will be part of what as investors we’re going to be betting on.

Mr. ARRINGTON: Would you put Twitter on that category and think they’re going to be able to monetize their traffic at some point, and users?

Mr. HOFFMAN: I think they’re already monetizing some and my guess is it will at least be a good business…

Mr. ARRINGTON: Yeah.

Mr. HOFFMAN: And just from my knowledge, I don’t know if it’s good or great yet.

Mr. SZE: That’s just something we don’t really know what their numbers are, so it’s hard to say.

Mr. ARRINGTON: Yeah, that’s true. It would be actually easy to speculate though.

Mr. HOFFMAN: That’s your business.

Mr. SZE: I think it’s easy – and we’ve seen in it all of our great companies too – it’s easy to say it’s not going to be true until it is proven true. And then, when it’s proven true, everyone catches up and says wow. So we’ve just seen that again and again in these companies so I wouldn’t doubt that it’s possible.

Mr. ARRINGTON: If you look at what’s driving the revenue in these companies, LinkedIn is – seems to be – largely an advertising based model so far. Right?

Mr. HOFFMAN: Actually, it is more a combination of individual subscribers and corporations.

Mr. ARRINGTON: Right. No virtual goods yet though.

Mr. HOFFMAN: No. Although, we may make one for you.

Mr. SZE: The Mike Arrington collectible.

Mr. ARRINGTON: Facebook’s a mix. I think it’s – I think virtual goods will become very important to them as Facebook payments launch.

Mr. HOFFMAN: Yeah.

Mr. ARRINGTON: Zynga, I think, is larger, it’s a virtual goods business, less about advertising. What does the future look like? I mean, you talked about Facebook is doing OK, can there be another Facebook. In terms of other players generating revenue, is it all about virtual goods in the future or will some sort of advertising model work in the social and gaming places?

Mr. SZE: Well, I think it is true by your comments that virtual goods today have been mostly happening in entertainment-oriented experiences so LinkedIn is a less relevant one because it is really about how do you improve your career and your opportunities. I don’t know that – I don’t know that virtual goods is a new phenomenon either. I mean, you’ve seen it in Korea. It’s a massive business. You’ve seen it in China as a massive business. You’ve seen it in Japan. The US has been a little behind on that but now we’re starting to see it so I don’t know that it’s a particularly new phenomenon in the big picture of things about human needs and desires. We’re just now getting to a point where it is in a critical mass here.

Mr. ARRINGTON: Yeah.

Mr. SZE: You sort of implied that it was either-or. I mean, advertising – Facebook is doing great on the advertising.

Mr. ARRINGTON: Yeah.

Mr. SZE: I don’t think it is new – the nice thing about this business is you can have both.

Mr. HOFFMAN: Yeah. I think basically all three areas are actually very lucrative business models. I think that they – and I don’t think it will be limited to just these three companies. I think other companies will be able to build up as well. I think it will be even interesting, part of where massive pots of gold will be discovered is when people think of new either configurations or new types of business models.

Mr. SZE: You mentioned LinkedIn – I mean, Pandora has switching business and is doing very well as well.

Mr. ARRINGTON: Yeah, they have a cost side of their business too on the music so the fact that you put them in the running as an IPO candidate is something fascinating. But that means, you know, real revenue but also actual profitability at some point. So I know they’ve actually said they’re profitable, but IPO-level profitable… interesting. You’re not going to jump into that.

Mr. DAVID SZE: No, I’m not.

Mr. ARRINGTON: How real is all this location stuff, FourSquare and, you know, Gowalla as an investment? I mean, what – how real is any of this?

Mr. HOFFMAN: Well, I think it’s very early days. So what you see is a large number of nascent players even with some early traction.

Mr. ARRINGTON: Yeah.

Mr. HOFFMAN: All of it, even the traction, all of it is small as yet, but…

Mr. ARRINGTON: So you don’t think FourSquare is sort of by default born(ph) at this point.

Mr. HOFFMAN: I think – no, certainly not.

Mr. ARRINGTON: Yeah. Right

Mr. HOFFMAN: I mean, I think that the…

Mr. ARRINGTON: That jas nothing to do with the fact that people invest in Gowalla…

Mr. HOFFMAN: Well, but actually – usually when you’re asked these questions, like look if we had thought that, we wouldn’t have invested in Gowalla…

Mr. ARRINGTON: Which came first…

Mr. HOFFMAN: It’s not a question because…

Mr. ARRINGTON: Fair enough.

Mr. HOFFMAN: So – but actually I think what’s interesting is it’s kind of very early wild west which is… I’m not sure that the things that exist there are the things that are the mature – like what happens when we have a – everyone has a Smartphone in their wallet, what is the behavior or the way that their lives has changed, etcetera. And so I think it’s all kind of this land rush while people are still figuring out what are the core value propositions, what are the core ways that we relate to our physical environment, to other people in a location base…

Mr. ARRINGTON: Yeah.

Mr. HOFFMAN: I think that’s like we’re here when the actual story is this.

Mr. SZE: I think the location aspect is something that we do believe is the piece of the story and is going to be part of a need that’s going to get solved. I mean, it’s always been in there and it’s just starting to hit it. You know, we were very excited about the space that Gowalla is in and we believe it’s got a lot of legs but, you know, there’s – it’s got a whole set of developments before that lead up to that. Now the capabilities of data and mobile is the real kind of turning point, I think, that’s really kind of changing that, and you could see it before in Twitter, you know, the number of this stuff that was going on in Twitter was tweets about my location. Right? I’m here doing this. And so by making a specific aspect that can then publish into those systems, Facebook and Twitter, but specifically around location, I think there’s a very rich opportunity and we’ll see.

Mr. ARRINGTON: Yeah. Why is it taking Facebook so long to jump into the space? Is it they want to wait and see what works, concerns about privacy…

Mr. SZE: You’d have to ask them. I mean, that’s not a thing that we’d comment on the companies…

Mr. HOFFMAN: Although, I’ll just say that Facebook is very successful on what they’re doing and I thought it’s right so people are checking in…

Mr. ARRINGTON: It’s the most popular mobile…

Mr. HOFFMAN: So – and I think – look, not commenting on their intentions, but they have a huge mobile presence already with a bunch of features and a bunch of desires from people to iterate on those features. So this kind of geolocation… just becomes a – what’s their priorities versus the other the features in this massively successful product.

Mr. ARRINGTON: So it is fair to say they can then wait and see a little bit…

Mr. HOFFMAN: Yeah.

Mr. ARRINGTON: And do it right.

Mr. HOFFMAN: Yeah.

Mr. ARRINGTON: OK. There’s a blurring of the line between these VCs and Angels today. Some VCs like Ron Conway are now raising 10 million dollar funds, some guys with 10 million dollar funds are raising bigger funds. This is an age-old question but it seems like it’s getting worse over time. What does a early stage VC fund really mean anymore? How do you guys, in your mind delineate between small investments you really can’t pay attention to because you’re doing a lot of them and we’re really backing and betting on this company?

Mr. SZE: Well I think that the most important thing we look for in partners is that they can help build companies and, you know, we have the – we have the opportunity to do that at different stages. The most of the Angel investors are designed to do it at one point in time and we can occasionally do it then when we feel it’s the right thing to do and the right partner.

Mr. ARRINGTON: What’s the smallest check you’ve written in the last year or two?

Mr. SZE: Two hundred K.

Mr. ARRINGTON: OK. And the biggest is – tens of millions?

Mr. SZE: Yeah. It’s over 10 million.

Mr. ARRINGTON: Yeah.

Mr. HOFFMAN: Look, I think that the key thing in all of these is how do you build massive successful companies. When you go early stage, there’s usually a lot of risks from uncertainties and so you have to figure out a way if you’re doing that to either very luckily pick a few or provide a good set of services across the number. As you begin to kind of go up that funnel, what’s most important from the entrepreneurial perspective is who are the people that are going to help me build the really massive opportunities. And the key thing either, I think, on the Angel micro VC stage and the VC stage is, are these people going to help me build a really big company. Right? And so, people are just kind of doing and is kind of throwing in a check and whatever that can help you for a little bit of time, right, but what you are really looking for – and I think they’re available at all levels is who is actually a good partner through the length of the company.

Mr ARRINGTON: OK. Last question. What kind of companies are you looking for right now? If an entrepreneur’s watching this and reading the transcript, tell them what you’re looking for and whether they should come to you.

Mr. SZE: Look. Part of our belief is that entrepreneurship is a bottoms up phenomenon, so I kind of hate that question because we will look at generalized trends but we spend 10 to 20 percent of our time doing that, and 80 to 90 percent of our time going out listening to and hearing from the great entrepreneurs what ideas they think are great.

Mr. ARRINGTON: You like to be surprised sometimes.

Mr. SZE: Yeah. Well, I was just going to say more often than not by the time someone is saying, oh, this is the trend I’m looking for, it’s usually over. You know, the, oh, I am the MySpace of x, I am the Facebook of x, I’m the Twitter of x… they’re done. Done. So, we listen to the entrepreneur. We try to have a fine tuning fork to understand what they are saying and whether that makes sense and know it when we see it. We don’t try to do too much predicting.

Mr. ARRINGTON: Yeah.

Mr. HOFFMAN: 100% agree. The other thing is massive breakouts within software. Like whether it’s consumer internet, mobile, enterprise that sort of thing is what we think we have a strong confidence in helping building really strong companies on. So that’s what one of the things – we’ll consider anything that an entrepreneur thinks is really, really good and thinks we would be good partners for, but those are things that we build confidence and services around in order to be…

Mr. ARRINGTON: That’s true.

Mr. HOFFMAN: …hopefully, the top pick for some folks.

Mr. ARRINGTON: In a year, do you think you’ll add Digg to that list of four companies that maybe think about an IPO?

Mr. SZE: I hope so. They’re doing great. They continue to do it, we will.

Mr. ARRINGTON: All right, guys. Thanks very much.

Mr. HOFFMAN: You can Digg that story.

Mr. SZE: Well, yeah.

Mr. ARRINGTON: Yeah. Thanks very much for your time.

Mr. HOFFMAN: Thank you.

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