Angellist: A Zero Capital, Infinite Carry Venture Capital Fund
Here’s the thing: AirBnB is the biggest hotel without owning a single room, Uber is the biggest transportation system, without owning a single car. Angellist will be the largest and most profitable venture capital fund, without deploying capital.
How does this work? The answer is technology.
1. Economics of a traditional Venture Capital Fund
A traditional VC fund works as follows: Limited Partners (= investors) commit money to a fund. This fund is managed by “experienced” people, who make the investors believe, that they know what they are doing. They are called the General Partners.
A simple example will demonstrate the economics:
Limited partners invest $500m for 10 years.
Management will get 2% management fee per year: This makes $10m per year and over 10 years $100m in management fees.
Moreover there will be 20% carried interest (short: carry) for the management. Carry is like a tax on the profits of the investment.
Taking into account the management fees, let’s imagine the fund invests all of the committed capital (less management fees) – $400m – and achieves a 500% return. The valuation of shares is $2bn in the end . This makes $1.5bn in profits ($2bn — $500m).
Carry is now 20% on the profits. This means: $1.5bn * 20% = $300m.
So as a consequence the management will get another $300m from the carry.
In the end of the day, if a fund is doing well, it’s all about the carry. $300m in profits.
2. Economics of Angellist
Angellist has a slightly different business model. Please read with caution, this post is not representing official press releases of Angellist; however, from an economic point of view, I am convinced that they are going to achieve the following.
a) 0% Management Fee — Invest to get technology going
Imagine a fund is like an operating system. Investors would not invest in management fee to pay for office, conferences and fancy restaurant visits, but they would invest in a “startup” to build software.
This software is built to automate the process of funding and bring venture capital online.
Angellist is probably burning $250k to $400k a month. But why? The reason is to build a venture capital fund without actually deploying capital.
b) Economics of Syndicates
There is a recent report from Angellist about the Economics of Syndicates. A syndicate creator or lead gets 15% to 25% of the carry of every investor in his/her syndicate and Angellist always receives 5% of said carry.
Most people only focus on themselves, especially investors and so they didn’t notice, that the 5% carry of Angellist basically builds a huge portfolio of startups and of future value in the form of carry.
For example, an investor like Jason Calacanis or Gil Penchina creates a syndicate and invests $25k and he gets backed by 100 accredited investors for a total of $500k. Let’s say the syndicate (by the way, just a glorified expression for “fund”) makes 100x on its portfolio of startups.
Then Jason made out of $25k a whooping $2.5m, but again the serious money is found in the carry:
$500k * 100x = $50m. So the profits for the syndicate are $49.5m. The 20% carry on these profits come out to roughly $10m.
Jason as the syndicate leader will pocket $7.5m and Angellist will get $2.5m from this investment. Jason invested $25k to receive $7.5m, while Angellist invested $0 to receive $2.5m from a single successful deal.
c) 1000+ Startups syndicated — Economics of Angellist
So let’s imagine syndicates will get popular and become mainstream and there will be 1000+ startups syndicated on Angellist a year. As a consequence Angellist will receive 5% carry of 1000+ startups.
Here’s the thing: 90% of the startups will probably fail. Angellist will not really lose money, because most of the syndication is run via software (variable costs is low).
10% of the startups will generate profits and will therefore generate a 5% carry for Angellist.
And — because of the power-law distribution — 1% of the startups will generate massive profits (like the next Uber or AirBnB) and those ones will generate massive 5% carry for Angellist.
The business model of Angellist is quite simple: It will generate most of the profits on the winners.
d) Business model Risks of Angellist
This sounds great in theory, but put in practice the case looks different.
First of all $1 in carry does not equal $1 in carry. Therefore a portfolio of carrys will never be as liquid or as unique as pure cash.
Moreover Angellist is moving in a highly regulated market. They have to deal and work with regulators and lawyers to make Angellist a reality. Those costs for lawyers are hard to estimate. Especially, a negative performance of Syndicates and only investing could potentially lead to sueing Angellist instead of sueing the Syndicate leads. Angellist could be liable for their product, lack of information or lack of communication. This is a risk, very hard to calculate, while traditional venture capital fonds are acting in an established and well regulated environment.
Finally, Angellist seems to be an easy product, but on the operational side of things, they have to take take on sourcing capital, managing the fund, dealing with regulators, banking, payment processors and collections, and handle pro ratas, accounting, taxes and distributions.
Those risks and costs are all reducing the potential upside of Angellist and therefore they are working very disciplined and focussed on the product and try to keep the burn rate as low as possible.
3. Conclusion: A zero capital, infinite carry fund
Because of the beauty of software and the possibility of scale, Angellist will not need to deploy additional capital like a traditional angel investor or venture capitalist, but at the same time Angellist will participate in theoretically every deal and has the chance to profit from every deal through the concept of carried interest.
Though, in practice there are a lot of regulatory and operational risks, which are a potential downside to the general business model of Angellist, it will be interesting to follow the journey of this startup.
Nivi and Naval are radically focussed on Angellist and therefore try their best to not get distracted, because they are on a 10 year journey to rebuild venture capital.
There are so many Hackathon Hackers, who don’t really see the value of Angellist and we believe that hackers will be the heavy users of Angellist in the long term. Therefore we believe, it’s time to meet with the best and most radical builders of Europe and explain Angellist.
- Syndicates and Seed Funds Economics (Angellist, May 2015)
- Darthmouth Alumni Magazine: The avenging Angel
- Venturebeat: Epinions settlement a black eye to VCs
- This Week in Startups: Naval Ravikant (#244)
- Venturebeat: Why Angellist will become the Android of Venture Capital
- Stanford University: Angellist and the changing landscape of investing
- Bernstein, Korteweg, Laws: Attracting Early Stage Investors: Evidence from a Randomized Field Experiment (May 31, 2015)