Sequoia's Evergreen Fund and the End of Traditional Structures

Sequoia Capital's transition to an evergreen fund structure represents a seismic shift in the venture capital landscape, fundamentally challenging the orthodoxy that has dominated the industry for decades. This move is not merely a tactical adjustment but a wholesale reimagining of how venture capital can and should operate in the modern era of company building and value creation, a hall mark of Venture Capital 2.0. To fully appreciate the magnitude of this change and its potential implications for the future of venture investing, we must delve deeply into the mechanics of Sequoia's new model, its advantages, the challenges it faces, and how it compares to the traditional fixed-term fund structure that has long been the industry standard.

At its core, Sequoia's evergreen fund, known as the Sequoia Fund, operates as a single, open-ended capital vehicle. Unlike fixed-term funds with a 10-year lifespan, the Sequoia Fund has no predetermined end date. This structure allows for indefinite holding periods, which aligns perfectly with the extended timelines many modern startups require to reach their full potential. In an era where companies are staying private longer and often take 15 years or more to reach significant liquidity events, this flexibility is not just beneficial—it's essential.

The mechanics of the Sequoia Fund are both innovative and complex. The fund is a holding company with stakes in Sequoia's portfolio companies. When a portfolio company goes public, instead of immediately distributing shares to limited partners (LPs) as a traditional fund would, the Sequoia Fund retains ownership of these shares. This retention allows the fund to participate in the continued growth of successful companies well beyond their IPO dates, a crucial feature in capturing the full value creation cycle of today's most successful tech companies.

To illustrate this, let's consider a hypothetical scenario. Imagine Sequoia invests in a promising AI startup called NeuralTech in 2023. Under a traditional fund structure, if NeuralTech goes public in 2031, Sequoia might be forced to distribute shares to LPs or sell them to return capital, potentially missing out on significant future growth. With the evergreen structure, Sequoia can hold onto these shares indefinitely. If NeuralTech's true potential is realized in 2035 with the widespread adoption of its technology, Sequoia and its LPs can fully participate in this upside long after a traditional fund has been forced to exit.

One of the most fascinating aspects of the Sequoia Fund is how it provides liquidity to its LPs. The fund offers periodic opportunities for LPs to redeem their stakes annually or semi-annually. This feature addresses one of the main criticisms of evergreen structures—the lack of defined exit points for investors. By offering these redemption windows, Sequoia balances the need for long-term capital with the liquidity requirements of its LPs. 

For example, if an LP invested $100 million in the Sequoia Fund in 2022 and its net asset value (NAV) has grown to $150 million by 2025, the LP could choose to redeem a portion of its stake during the next available window. They might redeem $50 million, leaving $100 million in the fund to continue participating in future growth. This flexibility allows LPs to realize gains or adjust their exposure while maintaining a stake in the fund's long-term success.

The fee structure of the Sequoia Fund is another area where it diverges significantly from traditional models. Instead of charging management fees on committed capital, as is common in traditional funds, Sequoia takes fees based on the fund's net asset value. This aligns the firm's compensation more closely with actual performance rather than fundraising prowess. For instance, if the fund's NAV is $10 billion and Sequoia charges a 1% management fee, they would earn $100 million in fees that year. If the NAV grows to $15 billion the following year, the fee would increase to $150 million, directly tying Sequoia's compensation to the fund's performance.

The carry structure is equally interesting. Sequoia takes carry on both realized and unrealized gains but is subject to certain thresholds and clawback provisions to ensure fairness to LPs. This approach allows Sequoia to benefit from the paper gains of successful investments but also includes safeguards to protect LPs from paying carry on temporary or illusory gains.

To illustrate this, let's return to our NeuralTech example. If NeuralTech's valuation skyrockets from $1 billion to $10 billion based on strong market reception, Sequoia will accrue carried interest on this paper gain. However, if NeuralTech's valuation later decreases to $5 billion due to market volatility or other factors, the clawback provisions would ensure that Sequoia doesn't unfairly benefit from the temporary peak valuation. This structure incentivizes Sequoia to focus on sustainable, long-term value creation rather than short-term paper gains.

Critics of the evergreen model often argue that it lacks the discipline imposed by fixed fundraising cycles and may lead to complacency. They contend that the pressure to raise new funds every few years keeps traditional VC firms sharp and forces them to deliver results consistently. However, this view fails to recognize the inherent accountability built into the Sequoia Fund structure.

Poor performance in the Sequoia Fund would lead to redemptions from LPs, naturally shrinking the fund and Sequoia's fee base. This creates a powerful incentive for continued strong performance and active portfolio management. In fact, one could argue that this model creates even more accountability than traditional structures, as Sequoia must continuously justify its investors' capital rather than relying on the inertia of 10-year lockups.

Furthermore, the evergreen structure allows Sequoia to take a truly long-term view of emerging technologies and markets. For instance, if Sequoia identifies a promising but early-stage trend in quantum computing, it can make small initial investments and gradually increase its exposure as the technology matures without the pressure of deploying a fixed amount of capital within a set timeframe. This patience and flexibility can be crucial in nurturing groundbreaking technologies that may take many years to reach their full potential.

The Sequoia Fund also creates a flywheel effect for the firm's ecosystem. Successful investments generate returns that can be reinvested into new opportunities, creating a self-sustaining cycle of value creation. This contrasts sharply with the traditional model, where successful funds often lead to larger subsequent funds, potentially pushing firms to make larger, later-stage investments that may not align with their core expertise.

For example, if Sequoia's investment in NeuralTech yields a 10x return, those gains can be immediately reinvested into new, promising startups without waiting for the next fund to be raised. This allows Sequoia to maintain a consistent presence in the early-stage market, even as some of its companies grow to become large, public entities.

The evergreen structure also provides significant advantages in talent retention and development. In traditional VC firms, partners often feel pressure to raise new funds and may be incentivized to focus on short-term metrics to boost their track record. The Sequoia Fund allows investment professionals to focus on long-term value creation and building lasting relationships with entrepreneurs. This can lead to better decision-making and more effective company building.

Moreover, Sequoia's evergreen structure might offer entrepreneurs a more attractive value proposition. With the ability to provide long-term, patient capital, Sequoia can position itself as a true partner in company building rather than just a funding source with a ticking clock. This can be a significant differentiator in competitive deal situations, giving Sequoia access to the most promising investment opportunities.

However, it's important to acknowledge that transitioning to an evergreen structure is challenging. One significant hurdle is regulatory compliance. The Sequoia Fund must navigate complex securities laws and regulations, particularly around ongoing valuation and investor reporting issues. The fund must maintain robust systems for regularly valuing its private company holdings and provide transparent, timely information to its LPs.

Another challenge is managing LP expectations and education. Many institutional investors are accustomed to the traditional fund model and may need time to understand and get comfortable with the evergreen structure. Sequoia must clearly communicate the benefits of this approach and provide robust reporting and transparency to build trust with its LPs.

The evergreen model also requires a shift in mindset for the entire organization. Investment professionals must learn to think in terms of building long-term value rather than optimizing for near-term exits or fundraising cycles. This can be a significant cultural shift that requires careful management and alignment of incentives throughout the firm.

Despite these challenges, the potential benefits of the evergreen model are too much to pass up. It addresses many fundamental misalignments in the traditional VC model, particularly around investment horizons and incentive structures. Allowing for truly patient capital enables VCs to support companies through their entire lifecycle, from early-stage startups to mature public companies.

The Sequoia Fund structure also has the potential to democratize access to venture capital returns. While traditional VC funds are typically only accessible to large institutional investors and ultra-high-net-worth individuals due to high minimum investment requirements and long lockup periods, an evergreen structure could potentially be opened to a broader range of investors. This could allow more individuals and smaller institutions to participate in the value creation of innovative companies, though regulatory hurdles need to be addressed.

As contemporary venture capital fades into extinction, emerging firms will adopt similar structures, recognizing that the future of innovation funding requires a more flexible, aligned, and sustainable approach. The frontier in this space will revolve around how smaller or less established firms structure themselves to attract the long-term capital commitments necessary to make this model work.

Sequoia's transition to an evergreen fund structure represents a key moment in the future history of venture capital. It addresses many limitations and misalignments inherent in the traditional fixed-term fund structure and provides a framework for truly patient, long-term capital. While it faces challenges and will likely evolve over time, the Sequoia Fund has established the weather vane for everyone in the industry.

References and Suggested Reading

Konrad, A. (2021). "Sequoia Capital Announces Major Changes to Its Fund Structure and Partner Compensation." Forbes. https://www.forbes.com/sites/alexkonrad/2021/10/26/sequoia-capital-announces-major-changes-to-its-fund-structure-and-partner-compensation/

Loizos, C. (2021). "Sequoia's Pat Grady says it isn't clear startups 'should be accelerating' right now — here's why." TechCrunch. https://techcrunch.com/2021/10/26/sequoias-pat-grady-says-it-isnt-clear-startups-should-be-accelerating-right-now-heres-why/

Primack, D. (2021). "Sequoia Capital's new model." Axios. https://www.axios.com/2021/10/27/sequoia-capitals-new-model

Griffith, E. (2021). "Sequoia Capital's New Fund Structure Could Be a Big Deal for Venture Capital." The New York Times. https://www.nytimes.com/2021/10/26/business/sequoia-capital-fund-structure.html

Savitz, E. J. (2021). "Sequoia Capital Reshuffles Structure to Focus on Longer-Term Investing." Barron's.https://www.barrons.com/articles/sequoia-capital-longer-term-investing-51635276068

Geron, T. (2021). "Sequoia Capital's New Structure Upends Venture Capital's Old Ways." The Wall Street Journal.https://www.wsj.com/articles/sequoia-capitals-new-structure-upends-venture-capitals-old-ways-11635282535

Pitchbook (2021). "The Sequoia Fund: A new VC model emerges." https://pitchbook.com/news/articles/sequoia-fund-venture-capital-model