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Weekend Analysis

3 theories for Sequoia’s gravity-defying fund marks

Sequoia has largely bucked the trend of double-digit fund markdowns. Valuation experts weigh in with theories on how the VC giant might have done it.

Talk to any valuation professional, and one of the first things they’ll tell you about pricing companies is it’s both an art and a science.

It means that despite financial theory and general guidelines—some of which I previously explored in detail—figuring out how much a privately held business is worth involves a degree of subjectivity.

LPs know this all too well. They regularly see VCs value the same company differently.

I kept that context in mind when I wrote about Sequoia‘s fund valuations in October. While my conversations with LPs and my review of PitchBook’s fund performance benchmarks revealed that most venture firms reduced their portfolio valuations between 15% and 25% in 2022, Sequoia has largely bucked that trend.

The legendary VC firm marked up 15 of the 19 funds with vintage years 2018 and later by 9.2% on average over the 12 months ended June 20, according to a University of California investments report.

I couldn’t help but wonder what drove Sequoia’s markups at a time when the rest of the VC industry has generally done the opposite. How was one firm able to defy the market rout across multiple vehicles?

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The LPs, VCs, valuation consultants, auditors and others I interviewed for this column all agreed that it’s impossible to know without reviewing the funds’ portfolio companies. Sequoia declined to comment.

Still, the experts offered a few theories that could explain Sequoia’s success.

Saved by public stocks

“My guess is the reason why you’ve seen a [valuation] uplift between Q2 of last year and Q2 of this year is that they hold public stock positions, and a lot of them doubled [in that period],” said Hans Swildens, founder of Industry Ventures, a firm that invests in companies and secondaries and is an LP for about 400 VC managers.

Swildens added that he thinks Sequoia’s private holdings are likely down like the rest of the VC industry “because no one is that special.”

In 2021, Sequoia famously changed its structure to a master fund that has the option to continue to hold companies after they go public. Indeed, the performance of many stocks that were backed by Sequoia when they were private—including DoorDash, Airbnb, Unity and Nubank—improved in the 12-month period.

Swildens urged me to check his theory against Sequoia’s SEC filings for their public holdings, and it turns out there are reasons to doubt this theory. The firm still holds many public stocks, but the documents revealed that most of those companies seem to be associated with funds older than the ones in the UC Regents portfolio report.

Inside rounds prop up valuations

My chat with Portage Ventures partner Stephanie Choo led me to another clue.

Choo told me that insider-led rounds have become very common during the downturn and that, in most cases, existing backers are offering companies better terms than new investors. While in most of the deals, VCs honestly believe in the future of the startups they are continuing to back, she mentioned that upholding valuations is also one of the reasons to double down on portfolio companies.

“We’re certainly seeing inside rounds that are [at a flat price] where people are fighting hard to hold the mark,” Choo said. “Great investors can orchestrate inside rounds because they have the capital [reserved].”

 


Ian Coffman, director with Houlihan Lokey’s portfolio valuation and venture fund advisory group, also told me that bridge rounds to the next financing is a common way to keep a valuation mark flat, and he is seeing many large VC firms employ this strategy. But without that fresh round, there may be an argument to write down the value of the company if its growth rate has slowed substantially. And even for insider-led deals, investors prefer to have at least one new investor to help validate the price, Coffman added.

Deloitte managing director Heather Gates, who leads its private company audit practice, said that while valuations of insider-led rounds are generally scrutinized closely by auditors and questioned by LPs, a firm of Sequoia’s caliber can certainly help more portfolio companies “weather the storm” than a smaller one.

Grand slam

While insider-led rounds could help a firm maintain valuations, it’s also conceivable that Sequoia’s funds have a few very strong performers that are driving up valuations.

Gates said that she would expect 2018-20 vintage to be down because their active investment period was during a highly inflated asset environment, but she’s come across recent situations where one or two “really big winners” skewed the valuations of an entire fund upward.

“If you invested in OpenAI in 2018, your portfolio is going to look amazing because of that one asset,” Gates said.

Sequoia invested in OpenAI in 2021, well before the release of ChatGPT took the world by storm and sent the startup’s valuation soaring.

There’s no question that the Sequoia brand has helped the firm gain access to premium deals over the years. Therefore, it’s conceivable that each of the 15 funds with a heightened value over the last year has at least one portfolio company that’s outperforming the rest of the VC market.

As for which companies those could be, time may tell.

Featured image by Julia Midkiff/PitchBook News

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