Sequoia Model Change: Reactions from Permanent Capital VCs

Sequoia's Transition to RIA Status: A Venture Capital Shift

Sequoia’s recent announcement of its intention to register as an investment adviser (RIA) and adopt a “singular, permanent structure,” as the firm described it, generated significant attention within the U.S. venture capital landscape.

However, the reaction may have been somewhat overstated. This move wasn't entirely unprecedented.

Contextualizing the Change

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Sequoia isn’t the inaugural U.S. venture capital firm to choose RIA registration. Furthermore, it isn’t the first venture capital entity that The Exchange has observed transitioning to a more enduring capital structure.

While the simultaneous adoption of RIA status and a capital pool free from rigid return timelines is noteworthy within the U.S., similar models have already emerged in other regions.

Insights from UK Venture Capital Groups

To gain a deeper understanding of Sequoia’s strategy, The Exchange consulted with several publicly traded venture capital firms based in the United Kingdom.

Discussions were held with Richard Matthews, COO of Augmentum Fintech; Vinoth Jayakumar, partner at Molten Ventures; and Nic Brisbourne, Managing Partner at Forward Partners. These individuals were previously interviewed during a prior exploration of the benefits and drawbacks of VCs pursuing listed status.

Key Advantages and Differences

The UK firms highlighted the advantages of extended investment timelines and broadened access to venture capital as an asset class.

According to these investors, Sequoia’s shift mirrors their own structure in its capacity to offer increased flexibility in returns timing – potentially enabling greater return optimization.

However, a key distinction lies in the beneficiaries of this flexibility.

Let's delve further into the implications.

• Longer Investment Horizons: Allows for more patient capital deployment.
• Increased Access: Broadens participation in the venture capital market.
• Returns Timing Flexibility: Potentially maximizes returns for investors.

The Strategic Evolution at Sequoia

Roelof Botha, a partner at Sequoia, recently detailed a significant shift in the firm’s operational model during a podcast appearance. He provided an extensive explanation of the changes Sequoia is implementing. Botha emphasized to founders that an IPO should be viewed as a key milestone, rather than the ultimate conclusion of a company’s journey.

This perspective naturally leads to the question of why an IPO should represent a definitive exit point for investors. The core of Sequoia’s new strategy revolves around extending the duration of their investments.

This necessitates the venture capital firm’s ability to maintain stock holdings over considerably longer timeframes. Registered Investment Advisors (RIAs) operate under different constraints than traditional venture capital funds.

Specifically, RIAs aren’t rigidly bound by the venture capital regulations that typically require 80% of assets to be allocated to private companies, with the remaining 20% in other asset classes. Consequently, a successful IPO can trigger pressure on venture capitalists to liquidate portions of their holdings.

Such pressures can sometimes result in premature exits, potentially limiting the full profit potential of an investment. This impacts returns for both Limited Partners (LPs) – the fund backers – and General Partners (GPs) – the fund managers.

A fundamental driver for venture investors is, of course, realizing financial returns on their investments.

Botha further explained on the podcast that Sequoia came to the realization that the most promising venture investments often “continue to compound,” with the majority of value being generated *after* the IPO. This observation is particularly relevant given the trend of private companies remaining private for extended periods.

However, it’s demonstrably true that substantial returns can be achieved by holding investments through their public debut. Shopify serves as a prime illustration of the potential gains from a post-IPO holding strategy.

A recent report by OpenView reinforces this point. Since Salesforce’s 2004 IPO, its valuation has increased by an impressive 210x. Similarly, Shopify has seen a 143x increase from its IPO price, and ServiceNow has grown 60x.

These examples highlight the significant returns – and corresponding benefits for GPs – that can be realized by maintaining investments after they become publicly traded.

Sequoia is actively factoring this into its planning. Botha revealed that the firm currently holds “$45 billion worth of public securities” within its U.S. and European operations. Managing such a substantial portfolio presents challenges under existing venture capital regulations.

This consideration is a key driver behind the restructuring of Sequoia’s operational model.

A Shift in Venture Capital Structures

Richard Matthews of Augmentum explained to TechCrunch that conventional venture capital (VC) frameworks often prioritize the interests of General Partners (GPs) over those of their investors and the companies they fund. The Sequoia Fund represents a move towards a more equitable distribution of benefits.

A key aspect of this new structure is its improved consideration of Limited Partners’ (LPs) limitations. Sequoia isn't creating a situation where capital is irrevocably locked in long-term investments.

According to Botha, during a podcast discussion, LPs will have the option to redeem a portion of their holdings in the Sequoia Fund annually. This allows for liquidity to be better aligned with individual investor requirements.

The effectiveness of this increased flexibility remains to be determined. However, it signifies a positive initial step in harmonizing the interests of both LPs and GPs. The goal is to maximize returns while simultaneously granting limited partners access to capital when needed.

Botha highlighted that some LPs may have urgent financial needs, such as funding educational initiatives or medical studies.

While VCs often emphasize philanthropic LPs, the involvement of entities like Saudi Arabia’s government investment fund or family offices is also significant. As Katie Roof, a Bloomberg reporter and former TechCrunch employee, pointed out on Twitter, venture capital extends beyond simply increasing the wealth of a select few.

Venture capital also benefits numerous foundations, pension funds, healthcare systems, and other organizations that invest as LPs, ultimately impacting individuals across all socioeconomic classes.

Enhanced Returns for Limited Partners

The Sequoia Fund will enable these LPs to capture more of the gains from public markets – a benefit they previously missed, even when Sequoia distributed shares. Botha noted that LPs typically sold these securities upon distribution.

He explained that for large endowments managing billions of dollars, receiving shares in an unfamiliar company without a dedicated equity desk presents a challenge. What alternative would they have?

Now, investors will be positioned to profit from both private and public market performance, creating a more comprehensive return profile.

A Shift in Venture Capital Structures?

A key distinction between the Sequoia model and a traditional initial public offering (IPO), as highlighted by our contacts in the UK, lies in who directly benefits – the firm’s clients, the Limited Partners (LPs), and the investment vehicles themselves.

Molten Ventures’ Jayakumar emphasized the goal of extending venture capital access to a significantly broader range of investors. Matthews concurred, stating that utilizing permanent capital allows participation from investors lacking the time or resources for conventional venture capital investments.

Impact Compared to Public Listing

The changes implemented by the U.S.-based firm, while positive, don’t achieve the same level of broadened access as a public listing would. Nevertheless, Jayakumar acknowledged that “there are many appealing aspects to this new model” adopted by Sequoia.

Potential for Wider Adoption

Is this a trend that will gain momentum? Jayakumar believes that “a considerable number of U.S. venture capital firms are carefully evaluating this approach.” However, Brisbourne expresses skepticism, suggesting that replicating this move requires a proven track record and a compelling portfolio to attract permanent capital investors.

Performance, rather than simply size, may be the determining factor. Jayakumar noted that a firm’s established relationships with LPs are crucial even to contemplate such a transition.

Our Perspective

This aligns with our own assessment, though we remain open to the possibility of being proven incorrect.

Looking Ahead

It will be fascinating to observe how many U.S. venture capital firms ultimately move away from traditional structures towards more adaptable models. Determining whether an asset under management (AUM) threshold exists that enables this shift will also be important.

While rolling funds are unlikely to adopt a permanent capital structure, the minimum AUM required might be lower than currently anticipated. Combined with potential venture capital IPOs in the U.S., the American venture capital landscape could evolve to resemble the British market over time.