Explained: Sequoia Capital’s new disruptive structure. What has prompted it?

On Wednesday, October 26, Sequoia said it was consolidating all its US and European venture funds into a single fund — the Sequoia Fund, an investment vehicle which, unlike all other VC funds, will not have a timeline in which to return money to investors (Image: Shutterstock)

Sequoia Capital Operations LLC, the world’s oldest and one of the most successful venture capital (VC) firms, with early investments in companies ranging from Google and Apple to Airbnb, Stripe and ByteDance, is disrupting its own business model before anyone else does so.

Sequoia’s United States and European funds will now be clubbed under a single large fund with no holding period. The announcement by Sequoia’s partner Roelof Botha demonstrates both Sequoia’s enormous clout and the rapidly shifting dynamics in private investment and the need to stay relevant.

What does the move entail?

On Wednesday, October 26, Sequoia said it was consolidating all its US and European venture funds into a single fund — the Sequoia Fund, an investment vehicle which, unlike all other VC funds, will not have a timeline in which to return money to investors. Limited Partners (LPs), or investors in Sequoia — pension funds, university endowments, and billionaire family offices — will invest in The Sequoia Fund, which will in turn invest in sub-funds across stages — seed, venture, and growth.

Why is it doing this?

“This new structure removes all artificial time horizons on how long we can partner with companies. It enables us to participate on their boards and help them realize their potential over the course of decades,” Botha wrote.

For decades, VC firms have had 7-10 year fund structures, the timeline in which they have to show returns to LPs. So while the first two to three years of a fund are spent deploying the money raised, year five onwards is generally spent finding an exit path — selling a buyer or by listing.

Most VC firms need to show exits and close the fund in seven to eight years. Top funds can extend this timeline to 10-11 years, but hardly ever beyond that.

The new structure will do away with all expiry dates. Botha cited the example of Twitter co-founder and CEO Jack Dorsey’s payments firm Square, which Sequoia first backed in 2011. It went public in 2015 at a valuation of $2.9 billion. During or soon after an initial public offering (IPO), investors generally sell a part of their stake. Five years later, Square was worth $86 billion, and now it is valued at over $117 billion.

As companies stay private longer and technology envelops our lives more than ever, Sequoia does not want the pressure of returning money within a certain timeline when it can make spectacularly more amounts of money simply by holding on, or in some cases even doubling down later.

Especially in the last two to three years, technology company valuations have skyrocketed. Tesla, worth less than $60 billion in 2018, is trading at over $1 trillion today.

How does this change things?

The Sequoia Fund can now hold on to its best performing companies, even after listing, for much longer. The holding period will last until whenever it deems fit, and gives the firm tremendous control over its own destiny.

Are Sequoia’s LPs okay with this? Couldn’t it be riskier for them?

The traditional 10-year VC model was set up in the 1960s, and until now, was meant to ensure funds return money regularly to LPs, and to ensure VCs are responsible. That hasn’t been an issue with Sequoia, whose record in the US and China are particularly enviable, with landmark early bets on defining companies. In fact one week last year fetched $9 billion for Sequoia’s US unit in IPOs, and that continued as Airbnb, Freshworks and other firms went public.

“For nearly five decades, we have delivered unparalleled performance to our limited partners, with capital distributions meaningfully outpacing capital calls,” Botha wrote.

Have other VCs done this?

Not yet. Even among the top VCs, very few likely have the brand, power and credibility of Sequoia to be able to pull off such a unique structure, upending the venture capital model itself.
Sequoia is also becoming a registered investment advisor (RIA), rather than just a VC; the new moniker gives it broader leeway to invest in public stocks, secondary shares and cryptocurrency assets.

Rival VCs Andreessen Horowitz and General Catalyst too became RIAs a couple of years ago.

What about Sequoia’s China and India businesses?

Those funds will work the same way as before, with 8-10 year funds, for now at least. While Sequoia China runs a hedge fund as well, Sequoia India has been run like a typical VC fund so far.

Any other reason why Sequoia is doing this?

While VCs have seen record returns in the last few years, competition has significantly increased too, from non-VC investors, first SoftBank, and more recently hedge funds such as Tiger Global Management, Insight Partners and Coatue Management. These funds have flexible strategies, move extremely quickly and are already raising more money than even the biggest VCs usually do.

Maneuvers by Sequoia and others are also likely an attempt to stay on top of the game as competition rises and more money chases the same companies.