Sequoia Capital just marked down to zero the value of its stake in the cryptocurrency exchange FTX — a stake that accounted for a minor percentage of Sequoia’s capital but as of last week likely represented among the most sizable unrealized gains* in the venture firm’s 50-year history.
It alerted its limited partners in a letter that it sent out to them this evening. (See below.)
No doubt those backers are collectively still processing the events of this week. They’re accustomed to startup failures; this is outright calamity.
When Sequoia invested in the Series B round of FTX in July 2021, the high-flying, Bahamas-based outfit was valued at $18 billion. Two months later, the company was valued by investors at $25 billion. In January of this year, FTX raised a $400 million in Series C round that brought its total funding to $2 billion and its valuation to a breathtaking $32 billion.
Now, following a series of missteps — that’s the best-case scenario — FTX didn’t just lose its rich valuation. According to the WSJ, FTX founder and CEO Sam Bankman-Fried told investors today that he needed emergency funding to cover a shortfall of up to $8 billion due to withdrawal requests received in recent days. Reportedly, he has been seeking a mixture of debt and equity.
It’s not surprising that Sequoia decided instead to write off its roughly $210 million investment. Presumably, others of FTX’s investors — including BlackRock, Tiger Global, Insight Partners and Paradigm — are shooting out their own communications to limited partners about making the same decision. (The Ontario Teachers’ Pension Plan Board, which invested directly in FTX, has a much broader base of shareholders who may be wondering about their retirement savings, even while their pensions are guaranteed.)
More uncharacteristic was Sequoia’s decision to tweet out the letter tonight after sending it directly to its investors. It’s hard to interpret the move as anything other than a clear signal that Sequoia wants to distance itself as far from FTX as it can, just as details of FTX’s abrupt unspooling continue to surface.
What is known already: Binance, an early investor in FTX turned into a fierce rival, announced on Sunday it was selling off its FTT holdings, the native token of FTX exchange, worth $529 million at the time, due to “recent revelations that came to light.”
Those revelations came courtesy of CoinDesk, which reported last week that Alameda Research, a trading house also owned by Bankman-Fried, had fully one-third of its assets in FTX’s own FTT token, raising questions about possible market manipulation as well as making it apparent that the two outfits were dangerously intertwined and thus vulnerable.
Binance promptly went for the jugular, tweeting about those “revelations” and dumping its FTT holdings and creating enough uncertainty that other FTT holders raced to unload their FTT tokens. By yesterday, a crippled FTX had collapsed at the doorstep of Binance, and after Binance said it signed a letter of intent to acquire the outfit (victory at a fire-sale price), the internet had its fun with the whole saga.
Except that the story is still unfolding, as it turns out. After conducting some due diligence, Binance said it was backing away from FTX. Specifically, it said in a statement: “In the beginning, our hope was to be able to support FTX’s customers to provide liquidity, but the issues are beyond our control or ability to help.” (Ouch.)
Bankman-Fried has since been searching for funds elsewhere.
He’s clearly not getting more money from Sequoia. The question is what happens in the very likely scenario that none of FTX’s backers want to throw FTX a lifeline. On the one hand, FTX’s fall is setting off fears of a crypto contagion. On the other, the risks to FTX are mounting. Very notably, the SEC has begun investigating whether FTX mishandled customer funds and looking into its relationships with other parts of Bankman-Fried’s crypto empire, Bloomberg reported earlier today.
It leaves a lot of firms with ties to FTX in a precarious position, including Sequoia. In just one potential scenario, FTX customers out billions of dollars will be focused on getting some portion of those funds back, possibly with the help of regulators.
Sequoia wants no part of that. Which may be why it stressed publicly tonight in its LP letter that it does “extensive research and thorough thorough diligence on every investment” it makes, and suggested that if FTX screwed up, it was after Sequoia’s checks were cashed.
We’ll see if that settles things. It seems as likely that for the firm and its co-investors, their $2 billion loss isn’t the end of this chapter.
Dear Limited Partner,
“We are reaching out to share an update on our investment in FTX. In recent days, a liquidity crunch has created solvency risk for FTX. The full nature and extent of this risk is not known at this time. Based on our current understanding, we are marking our investment down to $0.
Sequoia Capital’s exposure to FTX is limited. We own FTX.com and FTX US in one private fund, Global Growth Fund III. FTX is not a top ten position in the fund, and our $150 million cost basis accounts for less than 3% of the committed capital of the fund. The $150 million loss is offset by ~$7.5B in realized and unrealized gains in the same fund, so the fund remains in good shape.
Separately, SCGE Fund, L.P. invested $63.5M in FTX.com and FTX US, representing less than 1% of the SCGE Fund’s 9/30/2022 portfolio (at fair value).
We are in the business of taking risk. Some investments will surprise to the upside, and some will surprise to the downside. We do not take this responsibility lightly and do extensive research and thorough diligence on every investment we make. At the time of our investment in FTX, we ran a rigorous diligence process. In 2021, the year of our investment, FTX generated approximately $1B in revenue and more than $250M in operating income, as was made public in August 2022.
The current situation is developing quickly. We will communicate in a timely manner when more information is available. If you have any additional questions, please contact Andrew Reynolds, Marie Klemchuk and Kathleen Forte at: investorrelations@sequoiacap.com. For SCGE questions, please contact Kimberly Summe at summe@sequolacap.com.
Sincerely.
Team Sequoia
Footnotes:
Global Growth Fund III (GGFIlI) data is as of September 30, 2022 and is based on U.S. GAAP. The $7.5B is composed of $5.8B of unrealized gain and $1.7B of realized gain. which includes the General Partner distribution on May 27, 2021 pursuant to the 2021 Amendment. Past performance is not indicative of future results
Global Growth Fund III (GGFIII) refers to Sequoia Capital Global Growth Fund III – Endurance Partners, L.P. and does not include Sequoia Capital Global Growth Fund III – U.S./India Annex Fund, L.P., Sequoia Capital Global
Growth Fund III – China Annex Fund, L.P., and their parallel funds
*The unrealized gain for Sequoia’s $150 million investment was $62 million, which while significant considering it invested just last year, is smaller than one might imagine because it owned less than 1% of FTX. Sequoia also marks its private company investments at a discount to their last round.