Venture Capital is turning into financial engineering rather than genuine business-building. Technology can change this.
Andreessen Horowitz (a16z) likes to make news. Admired and copied by many, a16z is a big-brand VC firm that has managed to reshuffle what venture capital(-ism) means. Born out of the financial crisis, a16z managed to repurpose venture capital into an agency-like model.
a16z’s success has not come without a price. With billions under management, Andreessen Horowitz began opening one late-stage fund after another, and their investing has begun to resemble financial engineering rather than venture capital. Most recently, they started a $2B (!) late-stage fund. In other words, big brand VCs like a16z are beginning to stand shoulder-to-shoulder against big private equity houses and even banks’ own private wealth arms in a race to invest in the next investment round of the unicorn “X”. Cold strategizing, deal structuring and multi-tiered cap tables with pre-calculated outcomes on IPO outweigh genuine interest in building business models of the future.
What’s going on with VC?
A few days after UBER’s IPO flopped, it had never felt more true that perhaps too much private capital has flown into technology in the past ten-or-so years. Companies promising to “disrupt” the world have seen their valuations rise to extreme levels in the post-crisis world marked by a distrust in Wall Street and the financial markets in general.
What might have been a competitive advantage for a VC firm before — its industry niche based on partners’ background and network — is no more, when there are several similar funds knocking on the door waiting to invest in the same companies. That, in combination with the proliferation of knowledge and information in the Google-centric world of today (which discounts the significance of any advantage that one can extract from experience) reduces any significant differences between funds. There are no niches anymore. Rather, the opportunities for a big upside are in the crowded and exclusive UBER-like deals.
At the same time, VCs are considered the disruptors, but have remained virtually untouched by technology themselves. They are old parochial paperwork-heavy institutions. One incredible inefficiency is the lack of any standardized secondary market.
VCs (and private equity funds) have seen an incredible growth in the secondary market, as they are trading their stakes to address the mismatch between the investment horizons of their limited partners (LPs) and their ability to exit their investments. This is a result of the abundance of capital being concentrated in the private markets, which makes investing easier, but selling harder. It is also thanks to the fact that the rise in demand for these transactions has led to growth in legal and deal advisors focusing on the area, so that the process is not a blank sheet exercise each time round. But, there is no standardized single liquid market.
And so naturally, the question arises: How can technology improve VCs?
Security tokenization is shaping up to be one of the most disruptive trends in finance. At its core, it is about “cutting” real assets into regulated intelligent securities (“tokens”) tradable in a pre-programmed way on the blockchain.
Tokenization could be transformative for alternative investment funds: VCs, private equity and hedge funds. A tokenized fund would be offered to investors as a security that they can resell in the market. And it will be intelligent, so that it will know who can trade it and where it can be traded, or how it should distribute returns. A pre-programmed security with rules encoded within, will remove tons of paperwork and the need for middlemen. And being on blockchain, it can be traded instantly, globally and 24x7x365.
This can open up the VC model to be accessible both from the bottom-up (to more investors), as well as the top-down (to young-but-not-yet established fund managers). A much larger group of investors would be able to invest in the tokenized VC funds thanks to the removal of lock-up, the liquidity and lower minimum investment. At the same time, tokenization UBER-izes the fundraising process by removing the institutional apparatus that are presently needed to connect managers and investors. It puts emerging talent on the same level as established veterans. Imagine the access to alternative funds investment being as simple as lending on a P2P platform.
The profundity of the technological advantage that tokenization can bring hasn’t gone unnoticed. Several tokenized funds have emerged, each of which has been domiciled in one of the exotic jurisdictions recognized for their flexible regulation. This was necessary because there was no legal framework to regulate the new technology.
But, since then, the countries that are perhaps most recognized for wealth management — Switzerland, Liechtenstein and Luxembourg — have embraced the new technology and have begun to form the necessary rules. They are on a path to pass their own versions of a “Blockchain Act” that will recognize representation and transfer of securities on blockchain without intermediaries. Thanks to the progressive-yet-strict procedures in these countries, it is possible to tokenize a fund and attain legal certainty even now in a regulated manner compliant with the incoming framework.
Clearly, big players like a16z are not steering VC in the direction that it needs to go in order to do good: help to build sustainable businesses, rather than creating tachycardic start-ups with sacrificed moral core. Instead, the answer to this lies not with the big firms that are seemingly morphing into financial institutions, but with the tokenization of VC. By embracing the kinds of technological developments that have done them so well in the first place, VCs can blow the industry wide open, benefiting both investors and the companies they invest in, and be done with the institutional apparatus that only benefits the few.
bardicredit provides turnkey fund tokenization services helping fund managers to use tokenization for easier capital formation. Our services cover legal, regulatory and accounting, and ultimately the tokenization process.
bardicredit is a member of the Alternative Investment Management Association (AIMA), a global association of hedge funds, private equity and VC funds with more than $2 trillion under management.