In August, I wrote that venture capital as we know it is ending. Self-proclaimed “VC funds” faced a choice: They could try to scale up to meet the coming onslaught of cash from the global financial community entering private software investing, or they could look for new forms of venture financing beyond software and traditional technology.
In the context of that discussion, I am impressed with the bold moves Sequoia Capital announced this week: Instead of offering the typical time-limited funds, the firm will have one big fund, the Sequoia Fund, which will be open-ended, meaning it never has to return capital unless limited partners explicitly choose to redeem. The metafund will allocate funds to more traditional-looking VC subfunds for venture investing. And of course, the firm will become a registered investment adviser so that it can deploy a much broader range of strategies in the public and crypto markets.
Candidly, I wish I had a real knock on this strategy. (I like to play the contrarian.) But in this case, I think the power of the move Sequoia is making here is actually much greater than people realize—though not quite the “fundamental disruption of venture capital” that Sequoia advertised in its announcement, which is a tad grandiose. But still, as the investing world gets faster and stranger, there are lots of reasons why this move makes sense. That goes in general for VC firms, but particularly for Sequoia as it tries to fend off the onslaught of hedge funds and private equity firms and leverage its current position in the VC market.
Here are a few of the advantages, from most to least obvious:
1. The AUM Advantage
Anyone paying attention knows that if you want to survive as a non-seed fund, you need to be really, really big. As the market gets more competitive and transparent, you might not get the same multiples on investments anymore, but you can make up for that with volume.
In this respect, Sequoia’s move makes a ton of sense. On the basis of deployable capital, Sequoia is a small fish compared to other venture firms like Andreesen Horowitz. But by wielding its full assets under management1, Sequoia becomes overnight the largest traditional VC firm in the Valley (though still much much smaller than some of its East Coast rivals).
Aggregating everything into a master evergreen fund means that rather than thinking of itself as just the dollars it currently has to deploy, it can start to operate as the sum of all its AUM. The difference is enormous—transforming Sequoia from an institution with at most a few billion dollars of dry powder to a juggernaut with $45 billion–plus of public equities under its belt (and another windfall soon to come from Stripe).
2. The Agility Advantage
The days of big VC firms working one fund at a time are long over. Just like private equity shops and other diversified financial institutions, venture capitalists are running many funds in parallel with different managers and different strategies.
The problem is that without a master fund, that’s a real pain in the ass. Funds end up with strange dynamics where, for instance, they might tell a LP that in order to invest, they also have to invest in another, possibly less attractive vehicle. Not only does this strain LP relationships, it also slows down the speed at which institutions can spin up new funds to meet new opportunities.
Sequoia’s new model will dramatically reduce the friction involved because any new fund will have only one LP: Sequoia.
3. The Recruiting Advantage
In the era of the solo capitalist, the big venture firms are facing a talent problem: Why join a behemoth when you could strike out on your own, easily raise capital, not have to deal with intra-partner politics and take the lion’s share of the earnings for yourself?
My suspicion is that Sequoia in particular has been pondering this over the past few years. Take an example from its very own backyard: Matt Huang left Sequoia to co-found a crypto VC firm, Paradigm, in 2018. That firm, by all known measures, has crushed it, while Sequoia largely sat on the sidelines of the crypto boom, a mistake it’s now working hard to reverse. I don’t know the details on any of this firsthand, but if I had to guess, Sequoia must have asked itself why the platform couldn’t accommodate what Huang went off to build.
If you want to scale dollars, you need to scale talent, and the idea that talent wants to sit in a room scrapping over deals and arguing about carry is just wrong. It doesn’t matter how “golden” a business card is.
But with a master fund and on-demand subfunds, you can imagine how Sequoia will have a compelling argument for why its platform is better for the next great investors. In theory, at least, if you work for Sequoia, you could have your own fund with the firm as your sole LP. Sequoia could take care of all the hassles associated with managing LPs so that the talent can just focus on returns. This is a compelling future vision for how to attract and retain the next young crop of investors—not unlike models hedge funds have used before.
4. The Tax—and, More Important, Lending—Advantage
The tax angle should be clear to everyone. In a world where taxes are going up, setting up a structure where you don’t ever have to sell assets is generally a good idea (unless you’re tax exempt, which many VC LPs are).
The lending aspect, I think, is actually more important. The nice part about having tens of billions of dollars of liquid assets is that you can leverage them. If next-generation VC funds have a permanent capital base to draw on, then in a sense they end up looking like a new and improved version of a buyout fund. Rather than borrowing money for a specific deal against a specific dollar investment amount, they can borrow 100% of the dollars they need to finance all their primary investing activity against their big balance sheet.
Sequoia has said nothing about this, but if I were them I’d fund my next investment vehicles with debt versus asking LPs for more cash.
5. The Deal-Winning Advantage
In announcing the move, Sequoia partner Roelof Botha talked about long-term founder alignment and, in particular, about how Sequoia partners can be on founder boards “for decades” with this model. The board part doesn’t really ring true to me. After all, Peter Thiel has remained on the Facebook board long after he sold his Facebook stock. Botha himself has stayed on the Square board despite the fact that Sequoia distributed its Square equity long ago.
That said, this model will help the firm with founder alignment in a few specific ways. For later-stage companies planning to go public, the idea of an investor with a “hold forever” strategy is nice. Second, and perhaps more cynically, if Sequoia can build the ultimate founder club—where allowing the firm to invest in you means you also get to invest in the firm and be part of a permanent capital base for decades to come—that becomes quite a valuable founder perk. In competitive deals, that could shift the balance.
Where Do We Go From Here?
The ultimate question in my mind is whether this is a Sequoia-specific move—one that makes sense for one firm’s strategy to compete in the global finance ecosystem—or whether it’s going to become the new model (or at least a new model) for VCs. I’m sure many of them are discussing this right now. But in truth, most don’t have the brand, LP relationships, or balance sheet to take the same step. I don’t think others will rush to adopt this model.
But big hedge funds like Tiger Global Management and private equity firms should be nervous nonetheless. Because Sequoia not only now has the cash and flexibility, but it also has something they don’t: decades of relationships with founders in the Valley, experience helping scale the biggest businesses in tech and a network extraordinaire.
Well played, Sequoia. Game on.
1 AUM is a strange concept in venture capital, which hopefully moves like this will clean up. Most financial institutions talk about AUM as the net asset value of all of the investments they manage. Venture capitalists, however, typically talk about AUM in terms of how much money they’ve raised versus the value of their investments. One way to think about the move here is that Sequoia is basically framing AUM as other financial institutions do.