How Sequoia’s $2 Billion Dropbox Win Became as Big as It Is

Dropbox (DBX) doesn’t have a typical venture capital history.

And that means that Friday – when founder Drew Houston rings the opening bell at the Nasdaq – won’t be a typical IPO celebration for its biggest backer, Sequoia.

It’s an abnormally large win: The marquee venture capital firm owned 25 percent of the company before the IPO. And that percentage reflects a big lesson about Silicon Valley finance: It’s hard to get rich in tech if you aren’t early to a deal.

Sequoia, which as of now is poised to return between $2 billion and $3 billion on its initial investments, led the company’s first two new financing rounds, out of a total of only four. This means that the firm had less competition from new investors who would dilute its ownership stake. Sequoia also bought shares of the company at a drastically cheaper price than later lead investors – the valuation jump in Dropbox’s early years was wilder than other Silicon Valley darlings.

Those dynamics leads to a funky financial portrait. For example, Accel Partners – which did not lead any round but invested in the company’s Series A financing in 2008, which valued the company at $25 million – owns more of the company than Index Ventures, which led Dropbox’s Series B round three years later that valued the company at $4 billion, according to the company’s S-1 filing.

But the payday at Accel isn’t without some dispute, which originates with who gets the credit for the Dropbox success story. Sequoia’s lead partner on the company’s seed deal, Sameer Gandhi, left for Accel Partners in the spring of 2008. But a few months later, Sequoia made it a priority to cut Gandhi, now at Accel, into the company’s Series A deal, according to multiple sources with knowledge on the move.

That decision wasn’t nothing: It led to more than a $500 million equity stake for Accel.

Other early backers missed out a bit on some winnings: Y Combinator, the influential incubator that has marketed itself in part on birthing Dropbox, sold about half of its holdings to other investors at around the same time as the Series B financing round led by Index, according to a person with knowledge of the deal. This transaction hasn’t previously been reported.

That’s the only time that Y Combinator has ever sold any portfolio company’s shares in a secondary transaction, the person said – the money was directed to help fund Y Combinator operations.

Index, for its part, then had to buy shares at a substantially higher price than Sequoia, Accel and Y Combinator did, albeit with lower risk. Dropbox was so financially successful that it didn’t have to raise money between 2008 and 2011, a three-year gap during which the share price grew to 150 times higher.

Even rapidly-growing companies typically would raise a round – if not multiple rounds – between those share prices. But Sequoia, according to people with knowledge of the process, often told Dropbox in those early years that if the company needed more money, the venture firm could quickly supply the financing without the need for an external fundraising process.

In the eyes of some, the subtext was: We’ll take care of you – so no need to dilute our ownership position.

But Dropbox didn’t need it. Business was booming. Dropbox’s model was so strong and it was growing so rapidly in its early days that it was able to skip those traditional growth rounds – think financings that value a company at the hundreds of millions of dollars – and jump forward to 2011, when it was worth $4 billion.

The company would then go onto raise the Index round, a $350 million round in 2014 led by Blackrock, and then about $1 billion in lines of credit in two batches, the second as recently as last spring.

But Dropbox’s IPO filing earlier this month speaks for itself: This is a Sequoia company.

Sequoia did not start out with an unusually large percentage of the company in an early-stage deal – about 25 percent. But given how cheaply the firm bought into the company, it did not have to aggressively invest in later rounds after 2011 in order to maintain its ownership position. (Accel did participate in some later financing, or pro rata, to make sure it owned enough of the company.)

Sequoia has long had a particularly close relationship with Y Combinator, but Dropbox was not the hottest target among the YC batch of startups. There were competing companies – startups that later floundered like SugarSync promised to do the same thing. But Sequoia saw something in Houston and his co-founder Arash Ferdowsi, two highly-touted MIT engineers.

The company says the first outreach came from Sequoia’s Doug Leone. Also involved was Leone’s co-leader of the U.S. operation, Mike Moritz, who made a now-fabled trip to Houston’s apartment on Russian Hill in San Francisco on a Saturday morning.

“We walked into the Sequoia offices, and on the walls were the original stock certificates of Apple and Cisco,” Houston said in a 2011 interview. “It was daunting. I was thinking, Holy shit, I’m just some kid. What the hell am I doing here?”

Gandhi isn’t mentioned on the Dropbox page on Sequoia’s website. But it was he who later hammered out the terms with Houston over dinner, the CEO has said. Gandhi joined the board, but the Sequoia director seat eventually came to Bryan Schreier, a well-liked former Google sales executive who joined Sequoia in March 2008, a few months before Gandhi would depart for Accel.

Schreier has now served on the board for a decade and is one of Houston’s consiglieres. And he’ll be behind him at the opening bell on Friday morning.

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