New Sequoia Fund Stirs Speculation –

The mystery continues about whether Sequoia Capital allowed the University of Michigan (U-M) into its newest fund, after U-M spilled the beans about Sequoia’s internal rates of return.

Sequoia declines to comment on the issue. And despite being forced to release private equity IRRs through the Freedom of Information Act (FOIA), U-M says it doesn’t have to reveal if it’s an investor in $395 million Sequoia Capital XI.

Through a spokeswoman, U-M’s chief investment officer, Erik Lundberg, declined to say whether or not the university had invested in fund XI. There was no mention of the fund on the agenda for the meeting of the university’s board of regents in February (before the fund closed), but that doesn’t necessarily mean Sequoia left U-M out in the cold.

The issue is clearly of concern to the university. “Ironically, we may not be allowed into the new fund,” because U-M released private equity returns, says a university official. “We’re between a rock and a hard place. We want to be sensitive to the needs of venture firms,” but U-M is obliged to release the private data under FOIA.

U-M’s relationship with Sequoia dates back to at least 1992, when it invested in the firm’s sixth fund, a $100 million early-stage vehicle.

Some venture capitalists warned that public LPs that disclosed private equity returns would be frozen out of future fund-raising efforts, following the release of such data last October by the University of Texas Management Co. (UTIMCO) and the subsequent release of PE returns by the California Public Employees’ Retirement System (CalPERS) and California State Teachers’ Retirement System (CalSTRS).

Maybe Sequoia cut U-M some slack since the numbers it released show that Sequoia’s funds performed exceedingly well in the 1990s (see U-M report with IRRs for Sequoia and others).

Sequoia has been eagerly watched, since it is the first big-name firm to raise a new fund after the brouhaha. MPM Capital allowed CalPERS into its $900 million BioVentures III in December, but there was some speculation that MPM may have done so because it was intent on raising a large fund. Sequoia, on the other hand, raised 43% less in its 11th fund than it did with its previous fund of $695 million. It could afford to be very selective about whom it allowed to invest, and, in fact, each of the LPs in the new fund had to be satisfied with allocations that were one-third to as little as one-fifth of the amount they wanted to invest, according to a source close to the firm. If 200 institutions were let in (one published report said Sequoia fielded at least that many requests), each LP was allowed to invest an average of just $2 million.

It’s not surprising that investors were clamoring to get into the new fund. Of the 1990s-era funds (excluding 1999) that U-M invested in, Sequoia had the third-best overall performance, according to IRR data released by U-M for the period ended June 30, 2002. The only firms to outperform Sequoia were Kleiner Perkins Caufield & Byers (an average of 149.3%) and Matrix Partners (an average of 369.5%).

To date, Sequoia has posted an average internal rate of return (IRR) of 127% for the 1992, 1995 and 1998 funds that U-M participated in. Specifically, Sequoia VI (vintage year 1992), has posted an IRR of 100%, in contrast to a benchmark of 24% for similar funds raised that year, according to IRR data from U-M and benchmark data from VE. Sequoia VII (vintage year 1995) produced a 175% IRR, compared to a 51.2% benchmark, and Sequoia VIII (vintage year 1998) produced a 96% IRR, compared to a 32.5% benchmark.

The firm’s newer funds are still in the red, but that’s considered normal in the early years of a fund. Sequoia IX (vintage year 1999) has posted a 4% IRR, compared to a benchmark of 9%, while Sequoia X (vintage year 2000) has posted a 19% IRR, compared to a benchmark of 19.8%.

Sequoia’s successful fund-raising clearly shows that “quality rules,” says Bill Tai, a general partner in the Silicon Valley office of Charles River Ventures (CRV). “Those guys have been more than consistent, and even in this down market they’ve helped build some big winners-like PayPal and Netscreen, which have market values well over $1 billion.” To be exact, Netscreen (NASDAQ: NSCN) had a market cap of $1.5 billion, as of March 11. PayPal was acquired by eBay last October in a deal valued at about $1.5 billion.

While Sequoia declined interview requests (“We tend to be a bit camera shy when it comes to talking about ourselves,” says a source at the firm), General Partner Michael Moritz wasn’t too bashful to speak to BusinessWeek for an article published on March 3. The key points: Sequoia plans to make no more than 15 deals per year and it plans to reduce the average size of its first-time deals from $6 million to $3 million.

With 12 general partners, that’s just a smidge more than one deal per year per partner. (Venture Capital Journal was unable to obtain a copy of the fund-raising memorandum to see exactly how many GPs are listed, but Venture Economics-VCJ’s publisher-reports that the firm has a dozen general partners, plus two partners and two associates.)

One has to wonder with such a small fund if Sequoia will continue to maintain such a large staff. Several firms have let go of partners or associates to get costs in line with reduced fund sizes, including Battery Ventures, CRV and Mohr, Davidow Ventures.

Moritz didn’t tell BusinessWeek how much Sequoia would invest in total per deal. If you assume it will put a total of $6 million into each deal, the new fund will support a total of 66 deals, and, at 15 deals per year, the fund would invest for a little over four years. If you assume – probably more realistically – that Sequoia will put a total of about $12 million into each deal, the new fund will support 32 deals and run for about two years.

Either way, the message to entrepreneurs is that Sequoia is going to be extremely selective about the companies it backs.

The names of the investors allowed into Sequoia Capital XI were unavailable. Venture Economics lists the following as limited partners in previous Sequoia funds: AT&T Investment Management Corp., Alcoa Foundation, Avery Dennison Corp., Bush Foundation, Charles F. Kettering Foundation, Computer Services Corp., Darijac Corp., Dartmouth College, Federal Express Corp., General Electric Investments, HKH Foundation, Hughes Electronics, M.J. Murdock Charitable Trust, McKesson Corp., Norwich University, PaineWebber Foundation and the University of Minnesota.

Additionally, a knowledgeable source says previous Sequoia LPs include the Ford Foundation and foundations at the following universities: the California Institute of Technology, Columbia, Cornell, Duke, Harvard, the Massachusetts Institute of Technology and Stanford.