Are venture capital firms finally catching up with the innovation they’ve invested in for decades? Sequoia, one of the oldest and most successful VC firms, announced in October it is fundamentally changing its fund structure. Roelof Botha, a partner at Sequoia, believes this will be a revolutionary shift from an obsolete structure that has hampered growth across the industry. “Once upon a time the 10-year fund cycle made sense,” he says. “But the assumptions it’s based on no longer hold true, curtailing meaningful relationships prematurely and misaligning companies and their investment partners.”1
Traditional venture capital funds operate on a close-ended structure that involves creating a series of funds that open, invest, and close on a seven-to-10-year cycle. In this cycle, most initial investments are completed within the first three to five years of the fund’s life. The remaining time of the lifecycle is used as a harvesting period for the fund to make additional investments in existing portfolio companies. At the end of the fund’s lifecycle, returns are generated through a liquidity event.
Venture capital funds typically experience a liquidity event through share purchases, acquisitions, and initial public offerings. In a share purchase, the venture capital fund will either find a new investor to purchase their share of company stock or the portfolio company will repurchase the stock themselves. During an acquisition, a competitor will purchase a venture capital firm’s portion of equity to expand their offering, break into a new market, or acquire new technology. Initial public offerings allow funds investors to sell the company’s equity directly in the secondary market.2
Sequoia, who has operated on this traditional model for decades, is transitioning to a new structure that will allow them to offer increased liquidity to limited partners and expand their investment model. The firm will now be structured to consist of two interconnected funds – an open-ended master fund with a portfolio of publicly-traded companies and a group of sub-funds that will focus on specific strategies such as seed, venture, and growth.
With this structure, Sequoia will use the proceeds from selling positions in public equities to invest in the sub-funds, and proceeds from the sub-funds will finance the master fund. Limited partners will also find the increased liquidity more attractive than the traditional venture fund structure as they will now be able to request funds twice a year upon completing a lock-up period.3
Sequoia’s decision to reimagine their fund structure has already started to create a ripple effect in the early-stage investing world as VC fund managers and tech entrepreneurs alike voice their fervent excitement for the shift. After all, the benefits can be understood with a simple hypothetical: “What if Sequoia could have held onto Google?”
For context, their initial 1999 investment of $12 million was worth approximately $4.8 billion by the time they began unwinding their position in 2005. Had Sequoia decided to hold onto those shares —which the new fund structure would allow them to do- — their total Google holdings would be worth a mind-boggling $141 billion dollars, 30 times the value at which they sold at in 2005.4
Despite the general buzz surrounding this change, what works for Sequoia may not work for every VC firm. Sequoia’s newfound freedom to hold equities past their IPO will inevitably increase their exposure in secondary markets, and not every VC investor will have an appetite for the world beyond Series funding.
Time will tell as to whether Sequoia’s decision marks a revolutionary shift that reshapes the way venture capitalists invest. While there are certainly challenges to breaking the 10-year fund cycle status quo, every VC fund manager should be closely examining their own fund structure to determine if the strategic benefits can outweigh the cost of transformation.
1 https://medium.com/sequoia-capital/the-sequoia-fund-patient-capital-for-building-enduring-companies-9ed7bcd6c7da
2 https://medium.com/sogal-adventures/venture-capital-101-structure-returns-exit-and-beyond-2048f22247a5
3 https://pitchbook.com/news/articles/sequoia-capital-new-subfunds-structure
4 https://www.wsj.com/articles/SB110592331770527498