Venture Firms' Long-Term Stock Holding Strategy Proves Unsuccessful During Market Decline

Venture-capital firms that held onto stocks for longer than usual last year ended up regretting it when the market took a turn for the worse.

During the recent bull market, venture-capital investors that typically exit a stock after taking it public held on to their shares in the hope of maximizing returns. However, the sharp selloff in technology stocks in 2022 has dealt a punishing blow to that strategy. Some of the splashiest startup stocks from 2021 have plunged, making it unlikely that those investors will recover the value of their earlier positions anytime soon, if at all.

Altos Ventures Management Inc., an investor in Roblox Corp., held a $7.5 billion stake in the videogame company when it went public in March 2021. While it returned some shares, the value it retained swelled to more than $11 billion at the stock’s peak in November 2021, according to public filings. Then, the market soured, sending Roblox’s shares tumbling, and Altos’s gains with it.

The venture firm still held more than 60% of its IPO stake as of Sept. 30, an unusually large percentage for a company that went public almost two years ago. However, it has lost more than $5 billion on those paper gains in the first nine months of 2022, the filings show.

"The rise in the public markets was intoxicating for everybody," said Matt Murphy, a partner at VC firm Menlo Ventures. However, when that changed, many firms got burned.

At the end of 2021, Menlo Ventures still held around half of its shares in Poshmark Inc., which went public in January 2021. By that time, Poshmark’s stock had fallen more than 80% from its peak. Mr. Murphy said that most venture capitalists wish they had exited their shares more quickly last year, but the firm felt good about its exit timing on Poshmark stock.

VC investors are questioning their new approach after one of their investment plans backfired during a more than yearlong stock market retreat. This has lowered the portfolio values of many financial players and individual investors.

Startup investors typically exit companies once they have gone public to avoid market volatility. However, during the past decade-plus bull market, which accelerated during the pandemic, these investors changed tactics, according to venture capitalists and fund investors. Seeing the sharp rise of stocks like Zoom Technologies Inc. after their public listings, they decided to hold on to shares in the hopes of capturing some of those gains in the supercharged public market.

Sequoia Capital announced a new longer-term fund structure in the fall of 2021 that would allow it to hold shares in public companies indefinitely. The firm argued that this could allow it to accrue more profits over time. In addition to holding on to stock, the firm has purchased new shares in public companies including software provider Datadog Inc., public filings show. This is part of a broader trend among Silicon Valley investors.

At the Wall Street Journal's Tech Live conference in October, Sequoia partner Roelof Botha said that for great companies, there is much more return potential. He noted that you don't want to put an expiration date on your relationship with a great company.

Some venture firms have seen their paper gains shrink, and some have even lost money outright by holding on to shares. This is unusual for such investors, who typically acquire stakes in startups early on.

Sequoia Capital invested a total of $258 million in three funding rounds for Robinhood Markets Inc. beginning in 2018, according to the Wall Street Journal. The firm's stake was worth around $175 million as of Wednesday's market close, the Journal calculations show, translating into an $83 million loss for the firm.

If Sequoia had sold its shares when the lockup period expired in December 2021, it could have made a profit of over $240 million. However, Robinhood's shares have fallen by 55% in 2022, as the company has struggled with a drop in active users and falling revenue. This has damaged its long-term prospects and led to a wave of job losses.

Sequoia, which has been a vocal advocate of the strategy of holding public stocks, missed out on billions of dollars in potential gains for some of its largest stock positions, including software provider Snowflake Inc. Sequoia still owns the majority of its IPO shares in Snowflake, which went public more than two years ago, public filings show. However, Snowflake's stock has lost roughly 65% of its value from its post-IPO high.

A spokesperson for Sequoia declined to comment.

This year has been tough for venture capitalists, with a slowdown in startup deal-making and a drought in public listings. These losses further add to the challenges they are facing.

According to data compiled by Hamilton Lane as of September 30, 2022, venture capital firms were on pace to return the lowest percentage of assets they manage to their backers in more than 15 years.

The lower returns could decrease the fresh cash that these investors need to back new funds and slow down the pace of fundraising for new funds, according to fund investors. Venture firms typically distribute stock back to their fund investors, known as limited partners, who are then able to sell them on the open market.

The decision on whether to hold on to a stock after its public listing or stick with the more traditional approach can help define the difference between venture-capital winners and losers.

Khosla Ventures and Spark Capital both invested early in Affirm Holdings Inc., a financial technology lender that went public in January 2021. Spark Capital, which had a smaller IPO stake, unloaded its entire holding in Affirm by the end of 2021, returning more than $1 billion worth of shares to limited partners, public filings show. By contrast, Khosla Ventures liquidated less than one-fifth of its stake for less than $500 million by the same time, the filings showed.

As of Sept. 30, Khosla Ventures still held more than half of its IPO stake, whose value plunged by more than $600 million in the first nine months of 2022.

"We've seen more down cycles than most venture capitalists," said Shernaz Daver, a spokeswoman for Khosla. "Short-term dips are not worrisome if the fundamental business is strong."

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