The fading of VC has begun…
The slow but sure erosion of VC relevance in the modern economy
In the long run, the human race, the stars, supernovas, the galaxies will all extinguish.. So it’s not a question in a darwinistic evolution whether a specific species will go extinct. But, in the accelerated technological evolution that was triggered by the internet, many centuries and decades-old business models and businesses are fading out. With the new trigger of cryptocurrencies, another cataclysmic event, we will begin to see another series of species fade out. Those species operate in the business of money.
So the latest one to face the threat is the traditional VC model. Morning Brew brought me this news today. The famous Venture Capital firm Andreessen Horowitz which has long been a visionary in spotting the future and lending a helping hand in creating the future has sent an unmistakeable signal today — of deregistering itself as a Venture Capital firm.
Let’s examine the factors that are driving this erosion of VC relevance. See below a snapshot from Morning Brew.
Why might Andreessen Horowitz see what the other VCs cannot, or just yet?
The beginning of the threat to VC model
Brock Pierce spotted this quicksands phenomenon first when he launched a transformed investment vehicle Blockchain Capital in 2016 and raised around $10 million from token subscriptions. This fund would have a broader remit than a traditional VC fund, to invest in crypto related products, and the fund ownership is also through tokens. This was one of the first security tokens, long before the emergence of a new wave of security tokens in 2018 — solely as a response to hardships faced by founders in successfully concluding ICOs. Brock Pierce is one of the Silicon Valley evangelists who bankrolled the crypto movement by inventing and launching these pioneering vehicles.
Of course we all know what happened in 2017 and 2018. 1000s of ICOs were launched which raised capital ($5.6 billion in 2017 and $18+ billion in 2018) surpassing venture capital funding in the blockchain industry. Though the 2017 ICO funding came mostly from retail investors who were enamoured by crypto, most of 2018 funding came from institutions such as VC funds.
VCs navigating to the crypto world
Fortuitously, many traditional VCs had already started setting up crypto focused funds beginning mid 2017, to take advantage of the crypto boom. Around 350–400 new crypto focused VC funds were created in 2017–18. Now all these funds were ready to invest in equity as well as tokens in ICOs, crypto related firms, alt coins, albeit their appetite tempered by the crypto winter that emerged since May 2018.
This forming of 400 new funds is incontrovertible proof that even traditional VCs had begun to see the shift in the landscape, and they were not to be left behind in the new innings. Some Funds like Grayscale managed to raise $80m even after the crypto winter commenced, which is further proof that institutional money believes in the long term future of crypto, but the conditions have not been favourable for these funds to invest in new opportunities due to depressed market, and losses on early investments.
VCs clamouring for equity stakes in new crypto startups, where the startups cared to offer equity
Institutional Funds giving a green signal to crypto — the new asset class
Andreessen Horowitz VC fund has many firsts to its credit.
Andreessen Horowitz launched a16z Crypto Fund in 2017 to focus on investing in cryptocurrency-related technology companies at different stages. The fund was the first to attract participation from institutional investors such as Yale University endowment fund ($29.4 billion), University of Michigan Endowment ($12 billion).
Chris Dixon, Andreessen Horowitz’s general partner, said that it “plans to invest consistently over time, regardless of market conditions,” adding: “If there is another ‘crypto winter,’ we’ll keep investing aggressively.”
Top other public pension funds Fairfax County, Virginia’s Police Officer’s Retirement System, and Employees’ Retirement System invested in another crypto focused venture fund.
Morgan Stanley also declared crypto as an institutional asset class in 2018!
Exciting new startups started to offer only tokens, and no equity!
While the boom in prices of cryptocurrencies led by bitcoin and quick returns on investment, otherwise unheard of in stock or bond markets for decades, fuelled the frenzied appetite of many new funds incorporated to focus on crypto, the paradigm shift in business landscape brought about by blockchain and tokenisation was spawning many new industries that hitherto didn’t exist before. To educated and savvy observers like venture capitalists it was evident that a new crop of winners would soon emerge replicating the internet era winners like Amazon, Google, Apple. And these new startups had tasted blood with anti-dilutive capital raises thanks to crypto. These startups would build the infrastructure rails to operate in the new economy. The new age crypto-economy startups were doing ICOs and offering only tokens in their firms and not equity. This further disadvantaged the traditional VC who could not take advantage of this new ICO phenomenon due to multiple reasons (except for the far seeing visionaries who knew better and took advantage) :
- Fund Remit & Structure : They did not have mandates to invest in anything other than equity.
- Behavioral Psychology : They could not immediately persuade themselves of the benefits of buying tokens and not owning equity.
- Innovation-resistant incumbent thinking : They thought all ICOs were frauds and stayed out in the beginning, just like Warren Buffet who thought bitcoin was rat poison before and Jamie Dimon who thought cryptocurrencies were a scam before launching the JPM Coin, and Facebook which banned all crypto ads before announcing its own cryptocurrency for payments.
Disruption to the VC Model
Anti-dilutive capital
ICOs emerged as an anti-dilutive way of fund raising for entrepreneurs, which was a breakthrough in global capital markets. Though ICOs dated back to Mastercoin and Ethereum, the phenomenon of ICOs gained momentum in 2016 after Ethereum became popular, and reached a tipping point in 2017. ICOs are the most solid use case of Ethereum so far. Thanks to Ethereum, thousands of founders (both legitimate and scamsters) have raised money way too much and way more quickly than they would otherwise have in the normal startup life cycle of Friends & Family — ->Angels — ->VC — ->Series A — ->IPO.
(The capital you raise by offering equity is dilutive capital. The capital you raise without offering equity (by selling tokens for example) is anti-dilutive capital. )
ICOs were a run away success for over 18 months, and then when bitcoin price started to nosedive all market activity came to near stand still for ICOs. And the inventive breed of entrepreneurs once again took recourse to offering equity (dilutive fund raising) as well as some schemes called “Security Tokens”. Security Tokens offered some tangible returns tied to the product and the company as opposed to pure utility tokens, and allayed the concerns of investors who were used to equity mindset. However, these security tokens were far from traditional wall street securities, and still were anti-dilutive capital.
Anti-dilutive capital raising has become a new favourite
Apart from ICOs and STOs, many other anti-dilutive models are still emerging.
Clearbanc is a new era VC which wants to offer loans to startups at 6% instead of taking equity, and will take a percentage of revenues until the debt is paid back. This would be termed a Security Token in the crypto parlance.
Anti-dilutive capital raising is definitely a leap over new age accelerators and incubators like 500 startups, Y Combinator that are home to many of the current day Unicorns like AirBNB, Dropbox, Stripe, Reddit and Coinbase which has recently valued itself $8 billion, inspiring Michael Novogratz to state Crypto is no longer the current era tulip mania.
Crypto will play a big role even in dilutive capital, which also hurts VC further.
Yet another leap would be traditional securities offered as tokens, which are distinct from “Security Tokens” as described above. When that shift happens, all stocks , bonds and derivatives will have their token counterparts and wall street will be truly colonised by crypto.
This is an era of private unicorns. Companies are acquiring multi billion dollar valuations way before their public listing, thanks to VCs competing with other to fund these tech startups 100s of millions of dollars. Here VCs were definitely at an advantage of finding these unicorns early and taking massive private stakes in them before their equity was even available to others. Traditional VCs have become a fixture even in the modern trend of mega fund raising rounds pre-IPO. Andreessen Horowitz ranks first even in this list where VCs own high stakes privately in tech startups, before they go public. However, this is going to change in the new paradigm when startups see a way to raise dilutive capital also publicly.
Himalaya Capital Exchange (HCX) is the startup trying to build basic infrastructure rails for that last step of tokenising traditional wall street securities.
Our primary customer: Not so much the existing companies which are already listed, but companies (issuers) that need fund-raising and have never gone for public listing before. With this, we believe fundraising and capital markets will truly break through many geographical and investing barriers and will make the process of fundraising truly democratic for all entrepreneurs and democratise the opportunities to make money for small retail investors. This will be a boon for small and medium enterprises (SMEs) around the world, and for small investors who will now have the same opportunities to invest as mega unicorns, mega funds such as Softbank and mega VC funds.
Hello equality!
In that now distant looking horizon, where you can directly raise money from public at all stages of business cycle, do you still see any VC around? If you are only capable of imagining what you have already seen, you might see VC. But, if you are not imagination challenged, and can see the unseen, I doubt you will see VC. Atleast not in their current omnipotent omnipresent role!
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