Silicon Valley’s Dirty Secret (Part II)
Arlo Gilbert

Interesting idea. I’ve been similarly discussing the prospects of passive investing in startups with a few friends over the last few years.

Issues we’ve identified

  • Despite the known inefficiencies that you mention in the article, investor scrutiny serves a purpose in the marketplace — to make entrepreneurs put a best foot forward, make the best pitch possible, go get as many customers as possible, etc.
  • If you believe in market economics, the passive opportunity will appeal more to startups who can’t raise money alternatively. This should create adverse selection.
  • Passive investing makes a lot of sense for publicly traded companies, who at least have to go through all the scrutiny of being a public company. There is a lot more variety in startups, ergo a wider range of companies with better/worse qualifications or preparedness to take the money.
  • Availability of capital does not necessarily imply return will be generated at enough alpha to account for the risk. This could just make more capital available to people who can’t utilize it well.
  • Although the 2/20 scenario seems untenable, having an investor who helps build a business/provide oversight is also a valuable market function in some cases. If you don’t have that, will the same or similar returns be generated? I have met entrepreneurs who don’t need a ton of help and some who do.

Overall, I love the idea as both investor as a startup guy. But I do wonder about the unintended consequences. Nice post.