Why Their Multibillion Dollar Outcome Flipped The Script
Pre-2014: Insider Rounds Are The Funding of Last Resort
Post-2014: Why Are Insiders Letting This One Get Out?
When WhatsApp took $19 billion and joined Facebook, the industry headlines moved quickly from the buyout itself to Sequoia’s masterful funding strategy of the startup. After publicly leading a Series A, the firm put another $50m+ into the startup in two subsequent insider rounds, neither of which were disclosed publicly prior to the acquisition. Collectively a lot of other VCs closed their laptops after reading the news, put on their Patagonia vests and took a brisk walk down Sand Hill Road while wondering how to deal with this new reality.
What was the big change? A firm had led two successive ventures rounds into a portfolio company. And they were Offensive rounds, not Defensive ones!
Up until this point the idea that your previous round’s investors did the funding on your next round was pretty verboten and when it did happen, it was capital of last resort. Like, the startup couldn’t get a new investor to lead around at terms that everyone liked so insiders decided to do the round themselves — writing the termsheet and supplying some to all of the capital. This was typically a signal of company weakness, not strength. And the investors didn’t like to do it because besides the risk of doubling down on a company instead of spreading the risk to other new investors, it meant repricing the company that you had previously invested in. An insider mark was considered to be a less reliable estimate of actual value than a new investor offering to price the round (so LPs looked sideways at it, etc).
To be clear I’m not saying Sequoia/WhatsApp was the very first time inside rounds occurred that ended up benefitting the investors and the company so the VCs reading this can save their DMs to me about how they actually led an insider round prior to 2014. Nor am I suggesting that Sequoia was the first firm to lead multiple rounds for the same startup. But I am saying it was the biggest and baddest example of the game changing. There’s a reason that for a while after the deal, trying to do an inside round was called “pulling a WhatsApp.”
Now in 2021 we have a very different landscape. The larger multistage funds don’t hesitate to lead back-to-back rounds (or in recent cases like a16z/Clubhouse, back-to-back-to-back). And it’s not just a change in norms and increased fund sizes which has supported this transformation, it’s also the Opportunity/Growth fund phenomena.
Now so many multistage firms also have some sort of growth/late stage vehicle it’s also possible to split an investment over time between those funds. Basically you’re doing the Series A and or B out of the core fund and then the C or D out of the growth fund (more of less, round nomenclature across different situations is less consistent than ever). So the risk/reward profile of the earlier investment is in a fund aimed at those bets, and the theoretically less risky, but also lower returning (on a multiple basis) later stage investment is in its appropriate vehicle. This also often means that although you have the same firm leading multiple rounds it’s a different GP — the early GP prices the first round and the growth GP prices the second one. While it’s still under the same umbrella, you can imagine that these two individuals at least serve as a check and balance on each other. If the growth fund GP is simply marking up the deals of her colleague, to her disadvantage in the growth fund’s returns, she’d be working against herself.
There’s a lot of differences between VC 2021 and VC 2001, and the nature of inside rounds is one significant change that I rarely see discussed structurally. But it’s important!