Incentivising Conviction Over Asymmetric Information
The advantage of information asymmetry is a long standing building block of private investment strategy utilized by Venture Capital and Private Equity firms. Some have done quite well by relying on early access to unique private information about startups that others do not have.
High performing VC’s become experts in their markets of choice. They tend to specialize either in product or technological categories. They talk to founders, write thought pieces and read pitch decks day in day out. They have their finger on the pulse of the market. This is an asymmetric advantage when compared to founders who do not have the same insight into the market. A founder never knows for sure how unique their idea is but an investor hearing 20 pitches a day sure does. A founder doesn’t necessarily get insight into similar teams and their operations. An investor will engage with dozens of teams per month. This is the information advantage which should help a VC firm achieve the high returns they are infamous for.
However, most private investment firms perform only marginally or no better at all than the broader public market. In fact, according to the American Investment Council, in the decade preceding September 2020, private equity funds generated just a 14.2% median annualized return compared to annualized return of 13.7% for the S&P 500. This demonstrates that the information advantage held by private equity and VC firms has not led to consistent outperformance. If the goal of large institutional investors is to beat the market, they are clearly failing.
At the same time, the volume of private equity has increased at a steady rate since 1988 demonstrating demand from investors to invest in early stage projects.
One way to interpret the increasing interest in private investments over a long period of time is by examining the persistent (albeit at times irrational) conviction that investors have in certain market segments that they feel passionate about. VC’s have high conviction in their product or technological category of choice changing the word. They develop a hypothesis on how that market will change and place bets on start-ups which align with that hypothesis. This is in stark contrast to your average investor, who is more likely to bet on the future looking a lot like the present. This irrationally high conviction gets rewarded every now and then by a start-up that truly alters its market.
As David Heinemeir Hansson stated in a recent interview for Bankless, it takes delusional people to change the world. It is far easier to go with the flow than to venture down the rugged untraveled paths of novel industries, yet time has shown this is precisely how paradigms are shifted. Placing safe bets on the status quo does not propel humanity forward in memorable milestones, but rather stagnates and bottlenecks innovation.
So VCs play an important role in changing the world. They hold an informational advantage which is supposed to support their ability to fulfil their paradigm shifting role and to outperform the market. However, most don’t outperform the market. Something is wrong. Is it possible that information asymmetry is the problem?
Removing Asymmetric Information
We consider the possibility that removing information barriers when building innovative products might help projects move faster towards success. Equitably sharing skills, knowledge, and building blocks might help avoid roadblocks, collectively learn from mistakes, and grow the whole pie rather than one project’s slice.
So here is the hypothesis that we are on a mission to test at Sporos DAO:
Replacing information asymmetry with transparency will lead to better outcomes for more innovators.
At an operational level, we are implementing the following specific ways to test our hypothesis:
- Transparency of Knowledge via Open Source Software
- Transparency of Governance via On-chain DAO voting
- Transparency of Equity via token allocations enforced by legal company wrapper with a contributor friendly Operating Agreement and Equity Compensation Plan
- Censorship Resistant Meritocracy via Progressive Sweat Equity Distribution that gives voting power to contributors as they add value
In our hypothesis, we see founders as early sweat equity contributors and we see sweat equity contributors at the same level as capital investors. No fancy classes of equity with preference rights or super voting powers. Everyone earns the same simple sweat equity token as they perform all the way to a potential graduation event with possible liquidity.
Contributors need to provide transparency in their work and respectively investors need to provide transparency in investment terms. No secret boardroom politics. Everyone has to prove their conviction by making a public contribution of time, effort or other value that an average person who does not have the same delusional level of conviction would rather make towards a regular salary in a company they don’t care too much about.
Stated differently, we believe that innovators should have all the transparency they can get in order to find the best team there is anywhere in the world with the most relevant skills to execute on a delusional world changing vision. Likewise, innovators should have all the means and transparency feasible to find the tools, platforms and investors matching their mission in a way that aligns incentives from day 1 through to eventual success. Investors also deserve all the information they can get to place educated bets.
Working on something truly innovative is harder than hard. Removing artificial information barriers might be a helpful step to educate decisions. Still far from sure fire, but hopefully bumps success rates by a few percentage points. We will let time and public on-chain data be the judge.
If this experiment resonates with you, join our discussion or sign up for our product beta waitlist.
