Oct 26, 2021 - Economy

Scoop: Sequoia Capital just blew up the VC fund model

Illustration of a pattern of tree rings with the center ring as a dollar bill sign.

Illustration: Aïda Amer/Axios

Sequoia Capital, one of the world's oldest and most successful venture capital firms, is forming a single fund to hold all of its U.S. and European investments, including stakes in publicly-traded companies, Axios has learned.

Why it matters: Venture capital is the money of innovation, but the industry itself rarely innovates. This is a radical exception.

  • "We think the VC model is outdated," Sequoia partner Roelof Botha explains. "It creates an odd dynamic between us and founders, where on the eve of an IPO they're asking if we're going to have to get off their boards and quickly distribute the stock. Why should that be the default, particularly when so much value creation happens later?"

Details: The Sequoia Fund will serve as an open-ended capital vehicle; the sole limited partner for all future Sequoia "sub-funds" (seed, venture, growth, etc.). Sub-fund managers will decide on when to contribute assets into The Sequoia Fund, optimizing for their own return profiles.

  • Limited partners will keep accounts with the Sequoia Fund, with annual redemption rights, and make allocation requests to sub-funds out of those account balances. In other words, the closed-end funds and the open-ended fund will continuously feed each other.
  • Sub-funds will maintain Sequoia's premium fee structure, including a 30% carried interest, while The Sequoia Fund will have a <1% management fee and a long-term performance fee with what I'm told is "a very high hurdle."
  • Sequoia employees will contribute at least 5% of The Sequoia Fund's capital.

More: Sequoia also plans to become a registered investment advisor, which could let it expand its investments in areas like crypto and secondaries. The firm also told investors that it doesn't plan to ever become publicly-traded.

  • These changes won't immediately apply to Sequoia investments in India or China, such as TikTok owner ByteDance, although those platforms could eventually be incorporated.

The why: Sequoia argues that all of this is designed to better align interest between itself and founders, and itself and limited partners.

  • In terms of founders, the argument is about being able to remain involved and invested long after a company goes public. Roelof Botha, for example, remains on the board of Square.
  • In terms of LPs, Sequoia believes the traditional fund structure has prompted it to sell shares too early (including in companies like Google). One internal analysis of distributions over the past 15 years shows that had Sequoia held onto shares for just 12 additional months, it would have resulted in over $8 billion in added returns.

Tax consequences: Sequoia currently holds around $45 billion of U.S. and European public equities, on a cost basis of just $2 billion, and already has agreed to put much of that into The Sequoia Fund (including shares of companies like Airbnb).

  • The firm believes it crystalized the carried interest tax treatment upon making those transfers, while any future transfers would be at contemporaneous tax rates. Expect the IRS to take a very detailed look at Sequoia's analysis.

Timeline: The firm began discussing this concept nearly a year ago, in consultation with a select group of limited partners. Earlier this year it asked LPs to approve some top-level structure changes, without providing details, and this past Monday shared specifics. LP information sessions are scheduled for tomorrow and Thursday.

  • Axios spoke with three longtime Sequoia LPs, each of whom was supportive of the move. Part of this is because it puts the stock sale onus on Sequoia, rather than on LPs (some of whom might not have active public equities desks), but the bigger part is because Sequoia has never really steered them wrong before.
  • One concern is increased volatility, since The Sequoia Fund's value could be significantly impacted by tech stock swings. It's not something VC portfolio managers typically deal with on a quarterly basis.

The bottom line: Venture capital is often about fast follows, and rival firms might have called management meetings before getting to the end of this story. But the odds are that Sequoia will stand alone on making these sorts of changes, due to its outsized public holdings and its unparalleled brand reputation.

Go deeper