The decision by Sequoia to become a registered investment adviser (RIA) and move to a “singular, permanent structure,” in its own words, landed with a splash in the U.S. venture capital market. But perhaps it shouldn’t have made quite as many waves as it did.
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Sequoia was not the first United States-based venture capitalist to opt for RIA status, and it was also not the first venture capitalist that The Exchange tracks that moved to a more permanent-capital model. The combination of becoming an RIA and moving to a capital pool that isn’t beset with artificial return windows may be notable in the United States, but we’ve seen examples of this elsewhere.
To better understand what Sequoia is up to, The Exchange reached out to a number of publicly listed venture capital groups from the United Kingdom: We chatted with Augmentum Fintech COO Richard Matthews, Molten Ventures partner Vinoth Jayakumar and Forward Partners Managing Partner Nic Brisbourne. We’ve spoken to them before, when we previously explored the advantages and costs of VCs moving to listed status.
The firms extolled the ability to have a longer investment horizon and provide more general access to the venture capital asset class. The Sequoia shift, the investors told us, is similar to their own setup in its ability to provide more returns-timing flexibility — possibly allowing for greater return maximization — but different in whom it benefits.
Let’s talk about it.
The Sequoia shift
Sequoia partner Roelof Botha spoke about his firm’s model shift on a podcast the other day, giving us a somewhat long-form explanation of what it’s up to. During the show, he noted that Sequoia tells “founders that the IPO is a milestone” — not the finish line — for a company. So, he rhetorically asked, why “should the IPO be a destination for the investor”?
The comment gets at the crux of what Sequoia would like to do with its new model: hold investments longer, requiring the VC to be able to hold stocks over a long time horizon. RIAs are not beholden to venture capital rules requiring them to hold 80% of their assets in private companies, loosely, and no more than 20% in other assets. This means that if a venture capitalist scores a big win with a startup that goes public, there will likely be pressure to liquidate some of the VC’s position as a result.
This can lead to earlier-than-desirable exits in terms of returns, i.e., VCs have to return stock or cash to their LPs before the investment in question has had its full chance to generate profit — and, therefore, returns for both venture fund backers (LPs) and venture fund managers (GPs).
And if there is one thing that is true about venture investors, it’s that they want to get paid.
In the same podcast, Botha said that Sequoia “realized” that the best venture bets “continue to compound, and the majority of the value accrues after the IPO.” The balance has changed, we’d note, as private companies stay private longer. But, yes, it’s true that in some cases, big returns largely land post-IPO. Shopify is an obvious example of how money can be made holding through a public offering, to pick one.
A recent report from OpenView makes this point well, noting that since Salesforce’s 2004 IPO, it has grown its valuation 210x. Shopify, the venture group noted, is up 143x from its IPO price. ServiceNow is up 60x. There are simply massive returns to be made — and therefore huge checks for GPs — in holding certain investments post-debut.
The U.S. firm has this in mind. Sequoia has “been very patient with distributions for many years,” Botha said on the podcast, adding that his firm holds “$45 billion worth of public securities in our U.S., Europe business.” Hot dang. That’s probably hard to juggle with the venture capital rules that exist today, as we understand them. Hence the shake-up in the Sequoia model.
Hello from the other side
“Many of the facets of traditional VC structures are designed to optimize for the GPs rather than their investors and indeed the businesses they invest in,” Augmentum’s Richard Matthews told TechCrunch. In that sense, the Sequoia Fund is a step toward redressing the balance.
An important point is that it better takes LPs’ constraints into account. Indeed, don’t think that Sequoia is trapping itself or its investors into holding onto investments forever. LPs, Botha said during his podcast interview, will be able to “redeem a portion of [their] balance in the Sequoia Fund on an annual basis so that we tailor liquidity much more to people’s needs.”
It remains to be seen if the flexibility noted there will prove sufficient, but it should at least provide a solid starting effort toward balancing LP and GP interest in securing maximum returns while also providing limited partners with cash as they require. After all, Botha recalled, some LPs might have pressing liquidity needs “to fund some new educational campaign or medical research.”
Sure, those are LPs that VCs are always keener to talk about than, say, Saudi Arabia’s government investment fund, or yet another family office. But, as Bloomberg reporter and former TechCrunch staffer Katie Roof noted in a recent tweet, it’s also a reminder that venture capital isn’t just making rich people richer: “There are also many foundations, pensions, healthcare systems and other organizations that invest as limited partners and benefit people of all classes,” she noted.
With the Sequoia Fund, these LPs will now get more upside from public markets — which previously wasn’t the case even when Sequoia was distributing shares. “Sadly, LPs generally sold securities when we distributed them,” Botha said, adding that it made sense: “If you’re running a $5 billion or an $8 billion endowment and you get shares of some new company you don’t know and you don’t have an equity desk, what else are you going to do?” But now, these investors will get to benefit both from private and public market returns.
Power to the people?
Where the Sequoia model fundamentally differs from getting listed, our British sources told us, is that the beneficiaries are its customers (LPs) and products (investments). For Molten, Jayakumar explained, it was about “democratizing venture capital to a much wider investor base.” Matthews echoed that point, noting that permanent capital also opens up the venture asset class “to investors who don’t have the time, or scale, to invest in traditional VC structures.”
In other words, what the U.S. firm is executing doesn’t have quite the same democratizing impact as opening up access to more shareholders like being listed does. Still, “there’s a lot to like about it,” Jayakumar said of Sequoia’s new model.
Will it inspire others? Jayakumar is sure that “many other U.S. VCs are looking closely at it.” But Brisbourne doubts that just anyone can pull it off: “To date, this move is only an option for VCs who have the track record and portfolio to win the hearts of permanent capital investors.” It might not be a matter of size, but of performance: “It takes a fund like Sequoia with the strength of their LP relationships to even consider this kind of option,” Jayakumar said.
That is also our impression, but we would be more than happy to be proven wrong.
It will prove interesting to see how many U.S. VCs eventually do shake off their old makeup for something more flexible, and if there does wind up being an asset (AUM) threshold that makes the move possible. Surely rolling funds aren’t going permanent, but perhaps the minimum dollar figure is lower than some think. Throw in a VC IPO or two in the United States, and the U.S. venture market could start to look a little more British in time.
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