The venture capital industry has never had it better. The last three decades has seen technology led disruption of long surviving brick and mortar business models, which has allowed many a VC funded David to become Goliaths. Such rapidly scaled businesses which have become utterly dominant monopolies whilst still owned by the VC has prompted one of the oldest and most successful VC firms -Sequoia Capital to announce a radical change in the way its funds are structured. Typically, a VC fund has a pre-defined life, often ten years, by when the fund will have to return the money to its investors (called Limited Partners or LPs). A few days ago, Sequoia announced that “the firm will break from the traditional VC mold of fund cycles and instead, restructure around a single open-ended permanent structure named the Sequoia Fund.”
In this podcast, Patrick O’Shaughnessy quizzes Roelof Botha, a former Paypal executive and currently a partner at Sequoia on the rationale for such a paradigm shift. Here’s how Botha justifies it:
“The venture capital model as it exists today, the operating model was invented in the 1970s. If we go back to the 1960s, financings were actually organized on a per company basis. People didn’t have funds, and if you think about it from an economic theory point of view, the transaction costs were enormous. So, people had the idea in the 1970s of organizing a fund, you get investors to pre-commit, you organize the fund, and now, you can much more quickly invest in companies.
We’re in the business of investing in disruptors who reinvent industries and yet, the operating model for venture has not changed in 50 years. It’s kind of backwards. The other problem with the traditional model is we have closed-end 10-year funds. When we look at the reality of our business, we’re in the business of finding outlier founders who want to build legendary companies, companies that really stand the test of time. That doesn’t reconcile with a 10-year fund life. One of the things that’s been very strange for me is we invest in a company at the seed stage when there are two people and a rough idea. We help them find product market for the business model, help them recruit the right executive team, help them navigate crucible moments on the way to building a successful business. We tell the founders that the IPO is a milestone.
Why should the IPO be a destination for the investor? I’ve been on the journey now with several companies where I’ve been on the board for a decade or more. Why should the IPO mean that the venture investor has to get off the board? We have all the context, all the relationship with the founders, and an ability to help them continue to thrive, but the traditional model created the set of defaults, which is get off the board, distribute shares shortly after the IPO. We’ve struggled with this over the years. It just didn’t seem to reconcile with the reality of our business and the ambition of our founders.
The other thing that we realized was that for these great businesses, they continue to compound, and the majority of the value accrues after the IPO. So, if you think about it from the point of view of our LPs … In Sequoia, we work for what we call great causes. The vast majority of our LPs are endowments, foundations and nonprofits. We’re in the business of generating returns for them. So, if so much of the return happens after the company goes public, why are we selling the shares so quickly? The design of the Sequoia Fund is really aimed at meeting both of these objectives, helping founders with a far more durable base of capital and helping our LPs generate better returns.”
The rest of the podcast is interesting as well as it dives into Botha’s career discussing “what’s changed over the past 20 years, his days at PayPal, what legendary investors he’s worked with have had in common, and what he’s learned from being involved in businesses like Square, YouTube and Udemy”.
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