KOREA CAPITAL MARKET INSTITUTE

In October 2021, Sequoia Capital became the first global venture capital (VC) company that would establish an open-end evergreen fund called the “Sequoia Fund” and unveiled its plan to shift from the existing fund structure towards the Sequoia Fund-driven VC fund model.¹⁾ The Sequoia Fund is a fund of funds taking the form of an evergreen fund and has adopted a structure of incorporating an ordinary closed-end fund into its feeder fund. An evergreen fund refers to a fund without a fixed end date, differing from the 10-year fund structure commonly used by private funds such as VC and private equity (PE). Sequoia Capital’s shift in the fund structure highlights the proliferation of long-term capital that has taken place in global private fund markets for the past several years, gaining attention from overseas private fund markets. In the meantime, the PE sector has already seen global fund managers increasingly establish new types of fund vehicles deviating from the traditional fixed-term model since the mid-2010s. A case in point is the global private fund manager Blackstone that established a 20-year private equity fund worth $8 billion in 2020.²⁾   
  
Long-term capital can be categorized into an evergreen fund such as the Sequoia Fund and a long-term closed-end fund such as Blackstone. Evergreen funds are again divided into two types depending on whether they are publicly traded or not.³⁾ The evergreen fund model refers to open-ended funds with no termination date that allow occasional or regular investment and redemption, which necessitates an exit mechanism for providing liquidity and allocating returns to a limited partner (LP). Aside from Sequoia Capital’s fund, most evergreen funds have been intermittently managed by a few small- and medium-sized general partners (GPs), rather than by global leading private fund managers. On the other hand, a long-term closed-end fund has a fixed timeframe of 15 or 20 years despite having the same structure as traditional private funds, which is being offered by private fund managers including Blackstone, Carlyle, CVC, KKR, etc.
   
 
Drivers of the emergence of long-term capital
 
VC or PE is a strategy that makes an investment on the condition of the timely disposal of fund interests, tries to boost corporate value through support for growth, cost reduction, and governance improvement, and generates returns via exit strategies like IPO or M&A. During the seven- to ten-year fund life, the LP generally supplies capital and pays management fees to the GP and then receives returns allocated from the disposal of fund assets upon the termination. The pre-determined liquidation of a private fund offers many benefits, for example, pressuring the GP to exit from investment at liquidation and playing a key role in value addition. Amid recent changes in global private fund markets and corporate growth patterns, however, investors came to seek long-term capital as an alternative to traditional private funds. 
 
First, global private fund markets have seen a surge in fundraising volumes and intensifying competition since the mid-2010s, resulting in difficulties in securing investment targets and unfavorable investment conditions. This has made it hard to achieve high yields of the past, thereby requiring more time to generate similar levels of profits that had been realized in the past. Second, there are many cases where corporate value has risen tremendously after an IPO, compared to the pre-IPO period, meaning that the period for achieving optimal returns has been extended. Third, the private fund market has entered the periodic downward cycle where a growing number of traditional private funds have no choice but to dispose of fund assets at a discount due to difficulties in exiting their investment. These conditions have boosted demand for the fund structure that could better align exit timing.
 
 
Benefits and drawbacks of long-term capital
 
The growth of long-term capital has been affected by dynamics involving the GP and the LP. Global leading GPs with abundant fund managing experience have superior bargaining power over their relations with LPs and thus, they play a big part in the long-term capital expansion. This means that long-term capital is primarily beneficial to GPs and its specific benefits are as follows. First, the GP has a long-term or no obligation to return invested funds, which gives flexibility to choose exit timing. Second, uncertainties over periodic fundraising activities and a fund closure—being intrinsic to traditional private funds—could be curtailed or eliminated, which saves significant costs and resources. Third, the period for charging management fees has been extended to contribute to the GP’s stable income flow from management fees. Fourth, long-term asset management based on long-term capital leads to the low volatility of fund asset yields. This structure is suitable for asset and debt management of institutional investors who hold confirmed long-term debts such as pension funds and insurance firms, which helps increase the relevant market size. 
 
On the other hand, the following drawbacks of long-term capital overwhelmingly affect LPs. First, long-term capital is more likely to control fluctuations in returns than traditional models, possibly resulting in lower expected returns. Second, long-term capital still limits the LP’s ability to secure liquidity, although it offers them various options to exit their investment over the fund life cycle. Third, the prolonged fund management duration increases the possibility that fund managers or key personnel would be replaced or leave, adversely affecting performance and continuation of fund management.  
 
 
Evergreen funds: characteristics and considerations
 
The evergreen model and the long-term closed-end model have different effects on fund management practices, although both have emerged in response to changing private fund market landscape and evolving investee firms. Aside from its long fund life, the long-term closed-end fund structure hardly seems to be divergent in nature from the traditional private fund model. However, evergreen funds are an open-end fund instrument without a fixed end date, quite differing from long-term closed-end funds as well as traditional private funds in terms of essential aspects including fundraising, liquidity, and management fees and strategies. 
 
With respect to fundraising, once an investment target is located, an evergreen fund can raise capital at a time when it is necessary or anytime during a specific investment horizon. And it uses the same investment vehicle, enabling a swift and simplified investment process. Furthermore, the cash flow generated from the evergreen fund management can be put into investment. Thus, unlike the traditional private fund model, there is no need to establish a new fund every four to six years and to negotiate renewed investment terms. 
 
In terms of liquidity, evergreen funds have no definite fund life and thus, must set up a liquidity provision mechanism for LPs. How to devise the mechanism varies depending on whether the fund is listed or not. As for a listed evergreen fund, liquidity can be supplied by trading listed holdings within the stock exchange. But a non-listed evergreen fund can provide liquidity to LPs in ways that incoming LPs are matched with exiting LPs who seek redemption or that the fund purchases LPs’ holdings during the regular redemption period. Liquidity provision by a non-listed evergreen fund is based on its net asset value (NAV). But it is practically difficult to accurately calculate the NAV of an unlisted firm, from which various problems may erupt. In the meantime, the non-listed evergreen fund structure may face a rush of LPs’ requests for redemption, or a run on the fund during the regular period for liquidity provision. If a fund handles such redemption requests by urgently selling fund assets, it could have adverse effects on fund management.⁴⁾  
 
Lastly, both evergreen funds and traditional private funds charge a similar amount of management fees, but a core difference between them is the calculation method. Since the evergreen structure has no specific timeframe, its management fees are typically calculated based on a fund’s NAV, not on committed capital, or on some hybrid between a fund’s NAV and committed capital. As for performance fees, the calculation is not based on the internal rate of return (IRR) or the holding period return. Rather, performance fees are structured as being linked to gains in NAV. Compared with the approach adopted by traditional private funds or long-term closed-end funds, the evergreen funds’ calculation method linked to NAV gains motivates the GP to generate cash flow from strategic management by expanding market dominance of portfolio firms, strengthening industrial partnerships, and pursing M&A-driven growth, rather than focusing on realizing short-term returns. Simply put, the evergreen model allows the GP to keep holding stakes in well-performing firms and to sell its holdings of ill-performing firms at a proper time. With this process, evergreen funds could obtain sufficient capital that could be used for redemption.        
 
 
Implications for Korea’s private fund market
 
Although some LPs agree on the need for long-term capital, it could work to their disadvantage. In particular, the evergreen structure should resolve conflicts of interest involving valuation among LPs. Issues regarding GP disciplining that may arise from the indefinite timeframe also need to be addressed. Under these circumstances, it would take some time for long-term capital to take hold in Korea. In Korea’s private fund market where LPs still gain the upper hand, it would be difficult to obtain institutional investors’ consent for long-term capital. It is noteworthy that global GPs’ bargaining power against LPs plays a big part in the proliferation of long-term capital in overseas markets. Despite such a difference, the drivers of the emergence of long-term capital in overseas markets are relevant in Korea’s private fund market. Therefore, more attention should be paid to the potential of long-term capital to improve efficiencies in managing private funds and provide greater support for investee firms for the development of Korea’s private fund market.
 

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1) Sequoia Capital is a global VC manager with an asset value of $38 billion as of the end-October, 2021 and has recently invested in several unicorn companies in Korea including Coupang, Toss, Musinsa, etc.
2) Blackstone’s perpetual capital totals $197 billion as of the end of Q3 2021 which includes $110.1 billion in real estate property and $16.7 billion in PE, representing 37.3% of its AUM. Blackstone refers to such a long-term fund as perpetual capital.
3) In overseas markets, the concept of evergreen funds includes holding companies for alternative investments, BDC (Business Development Company), and MLP (Master Limited Partnership), in addition to evergreen funds related to VC and PE.
4) It is also possible to deal with a large volume of requests for redemption through gating restrictions or side-pocketing. But such tools are designed to limit LPs’ demand for liquidity, which could have adverse effects on widening the pool of LPs.