Sequoia Capital, one of the most prominent Silicon Valley venture capital firms, is mulling a set of sweeping changes to the way it distributes investment returns, a move that could help it avoid tax increases proposed by the Biden administration, according to people familiar with the matter.
Sequoia, which backs privately held companies, has asked its investors to agree to two key changes, said the people, who asked not to be identified discussing private information. First, Sequoia would make an early, pre-initial public offering distribution of some shares in portfolio companies, rather than waiting until after an IPO. Second, instead of distributing the shares directly to its general partners, Sequoia would hold the shares in a special purpose vehicle; no immediate payout would be made.
A spokeswoman for Sequoia declined to comment.
A person close to the firm said that the moves are aimed at restructuring some of Sequoia’s global funds in a way that it believes could drive better long-term returns. This person declined to elaborate on the terms of the restructuring and whether the venture firm will go through with the changes. Sequoia’s investors, largely endowments and nonprofit organizations that aren’t subject to most federal income and capital gains taxes, have approved the change.
The proposed revamp could deliver substantial tax benefits to Sequoia itself, depending on how and when tax changes proposed by the Biden administration are incorporated into law. The White House has advocated for ending a policy that allows for lower taxes on “carried interest” income, which venture capitalists earn as a percentage of the gains from their investments, typically 20% to 30%. Under proposed new rules, carried interest would be taxed at the higher rates paid on ordinary income, as high as 39.6%.
If Sequoia moves the shares into a special purpose vehicle, the firm could create a taxable event in the near term. That way, Sequoia could avoid subjecting itself to higher rates in the future. While significant hikes to capital gains rates could be retroactive to April under the White House proposal, changes to the treatment of carried interest aren’t due to take effect until 2022.
“They want their best shot at keeping a capital gains rate on their carried interest,” said Los Angeles tax lawyer Menasche Nass, who wasn’t familiar with the specific Sequoia plan because it hasn’t been previously reported. “This is their shot.”
Nass expects many investment firms will develop similar strategies to avoid a tax hit.
The stakes are high for Sequoia, which is expecting large windfalls from upcoming IPOs of portfolio companies such as payments processor Stripe Inc., most recently valued on the private markets at $95 billion Sequoia first invested in Stripe in 2010, the year the startup was founded. While Stripe’s exact ownership isn’t disclosed, Sequoia’s gains will likely run into the billions of dollars.
◦ From time to time, venture funds make big changes in structure. In 2019, Andreessen Horowitz legally changed its status to become a registered investment advisor, which at the time the firm said it was doing for greater investment flexibility. The move means Andreessen Horowitz can legally invest more than 20% of its capital in nontraditional venture assets, such as cryptocurrencies. Bloomberg LP previously invested in Andreessen Horowitz. In recent years, many funds have created SPVs to set aside additional capital for their fastest-growing companies.
The Sequoia restructuring has been under consideration at the firm since the start of the year, a person familiar with the situation said. No distributions from the special purpose vehicles will be made to Sequoia’s partners until distributions are also made to the firm’s investors, the person said.