The VC industry appeared to reach something of a watershed moment this week when Sequoia fundamentally restructured its vast portfolio into a single master fund.
Put simply, Sequoia plans to gather up all its fund commitments for its US and European vehicles and decant them into the newly minted Sequoia Fund, which will act as an LP and redistribute capital into its traditional venture funds while simultaneously holding onto companies after they go public.
With the announcement, Sequoia declared that as far as its business is concerned, the venture industry’s standard 10-year fund cycle is “obsolete.” It’s an innovative move for sure, and one that is perhaps overdue. But while it may help solve some problems, it could also be creating new ones.
The new model tackles a number of issues for Sequoia. The big one is flexibility. The firm can now hold onto its most valuable portfolio investments for longer in the hope of realizing bigger returns at a later date. Meanwhile, investors won’t be tied down with multiyear commitments, and will instead be investing into an open-ended portfolio. It’s a win-win situation, or so it would seem.
Liquidity, or the lack thereof, is a perennial problem not just in the VC industry but in the private markets in general. Often there can be a misalignment between investors and fund managers when it comes to holding periods.
LPs who prefer to have more liquidity have historically turned to the secondaries market, buying and selling fund commitments in order to recalibrate their allocation goals.
For VCs, trying to do the reverse and hold on for longer has actually been more difficult. This is because the traditional closed-end model brings with it pressure to exit and redistribute gains back to investors.
Unfortunately, the desire to hold out for bigger gains is stronger than it has ever been as high-growth, loss-making startups stay private for longer.
At the same time, late-stage VCs backing companies pegged to be the next Uber or Airbnb are competing with a new class of VC investors. Look at financial titans like Goldman Sachs, SoftBank and Tiger Global, who have deep pockets but aren’t bound by the rigid lifespan of a private fund.
This isn’t the first time a major Silicon Valley venture firm has attempted an exotic restructuring in a bid to cling to its assets for longer. In 2018, NEA launched NewView Capital Management to buy up a portfolio of tech investments from four of its other funds, specifically with a view to nurturing the growth of companies that have a longer path to liquidity.
NEA’s move was comparable to GP-led secondaries—a practice that has become increasingly common in the private equity industry.
With its evergreen fund structure, Sequoia is taking this need to its new logical conclusion. But to suggest that this represents the future for all VC may be slightly over-egging the pudding.
First off, it’s also worth noting that Sequoia could do this because, well, it’s Sequoia. Like NEA, the firm has a distinguished track record spanning decades, along with a loyal LP base that trusts the investor and its brand.
It’s reasonable to think that LPs won’t step over each other to commit to such a vehicle if it was for a VC lacking Sequoia-caliber prestige. For one, the potential for extra fees would be a turnoff. Sequoia doesn’t go into detail on its fee structure, but some reports reveal that the new master fund will charge a fee (under 1%) on top of the fees incurred by the underlying funds.
The bigger issue is that in this structure, the interests of LPs and GPs could be misaligned if the individual funds feeding the main vehicle aren’t under the same pressure to perform well. Traditionally, if a fund isn’t successful, there is also a downside for the GP. Under the model put forward by Sequoia, an underperforming sub-fund could be allowed to limp on, supported by sibling funds and generating fees for the manager, but not necessarily generating good returns for the LPs. There is a case to be made that this model will have less accountability.
Again, this may work for Sequoia’s investors, but does it represent a revolutionary moment for the VC industry as a whole? I’m not holding my breath. After all, the venture capital industry took some 50 years just to get to this point. In reality, any big fundamental change in the ecosystem as a whole will come the way it always has: gradually.
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