VC Firms and AngelList Syndicates: Friends or Foes?
A few predictions on the space AngelList syndicates are likely to occupy in 5 years.
This post is the second post of a Series of three posts, in which I summarize a few findings from the short thesis I wrote while studying at MIT. First interested in conducting an analysis of new strategies in VC and specifically of Platform strategies (see a summary of the first post here), I have spent some time at the beginning of the year interviewing industry experts in Europe and in the US. Discussing the topic with my advisor, we decided to extend the topic to equity crowdfunding syndicates, which are themselves another form of Platform in Venture Capital. In this post, I sum up a few findings in order to assess if traditional VC investors, even the most innovative ones, saw in equity crowdfunding syndicates the very disruption of their industry (and as such whether or not AngelList syndicates could become actual competitors of their firms). I also ended up building a few predictions on how VC relationships’ with AngelList syndicates were likely to evolve in the next couple of years that I relate at the end of this post.
What is an equity crowdfunding syndicate?
In June 2013, AngelList gave birth to a new genre of investor: online syndicates. These allow any individual to create their own “pop-up VC fund”. In the context of AngelList, this individual is called a “lead”.
Once AngelList has made sure that the lead complied with certain requirement in terms of personal wealth and/or annual revenue, he is allowed to pool investments from other accredited investors — “backers” — online.
Each time a lead finds an interesting investment opportunity, he can then offer the backers of his syndicate to choose whether or not they want to follow his investment decision. In exchange, the lead asks only for carried interest in case a successful liquidity event occurs. There are multiple benefits: the lead can invest in larger investment opportunities than if he was investing his sole money. He also multiplies his potential return on investment thanks to the mechanism of carry. Backers, who often don’t have time/expertise/network to access qualitative deal flow, can now invests in start-ups — which was before restricted to institutional LPs or wealthy business angels.
(For the sake of not making this post too long, I’ll avoid describing too much how online syndicates work. If you want to know more, this post does a great job explaining how it works.)
AngelList syndicates: the next big thing in VC?
First, considering the amount of money flowing in AngelList syndicates and its growth rate, they could soon become a primary source of financing — at least for seed startups. In 2015, $163M were invested through online syndicates, 53% more than in 2014 (see more here).
In other words, altogether, online syndicates invested in 2016 more than any other traditional seed funds.
If we quickly do the maths, investing $160M per year means that, if we multiply this figure by 5 — which is the traditional investment period of a Seed fund — it makes a seed fund of $800M. The comparison itself is not very rigorous because there are many different syndicates on AngelList. The sum of AngelList syndicates is also a much less homogenous entity than one single seed fund. Nonetheless, it makes a first good proxy to appreciate the growing size of the amount invested through online syndicates. (Last point on this, according to some early investors in AngelList, the run rate based on 2016’s first quarters could be above $500M flowing in Syndicates this year!)
Secondly, some of the most successful syndicates are now able to invest very significant amounts of money per deal. Gil Penchina is the lead investor on AngelList who can count on the largest backing per deal. He has been so successful raising money that he recently created a group of 25 syndicates called Flight.vc (see more here). Some of Flight.vc’s syndicates can now count on several millions of backing per deal (the biggest one has around $7M in backing per deal). It means that, with one of his syndicates, Gil Penchina is able to lead a Series A round. In fact, in 2015, he actually priced several Series A rounds, but also participated in several B rounds (he tells more in this interview). Now, an interesting point to notice here is how large the equivalent VC fund would need to be in order to match the size of Gil Penchina’s biggest syndicate.
Let’s consider that he invests each year “only” 5 times a ticket of $2M. After a 5 year-investment period, it makes 5*5*$2M i.e. the equivalent of a $50M fund size. Said differently, any significant lead investor on AngelList has the same “firepower” than a lot of Micro-VCs.
To put it short:
- For individual investors, AngelList syndicates could be an easier way to become a professional investor.
- For entrepreneurs, AngelList syndicates might become a viable way to raise funds, at least in the early stage.
- It could even be a new way for institutional LPs to deploy capital. CSC Upshot or Maiden Lane are two examples of new investment vehicles funded by Institutional LPs, which mission is to back directly online syndicates’ lead investors. (This model could also be another illustration of the “unbundling” of Venture Capital predicted by Naval Ravikant in 2010). The schema below gives a brief overview of the mechanics of how Maiden Lane works:
Now, are AngelList syndicates really a threat to big VC firms?
While all this seems very promising, let’s not forget that the only criteria to determine whether or not AngelList syndicates are actual competitors of traditional VC firm is their ultimate performance at the end of a first Venture Capital cycle. In other words, online syndicates could eventually be the next primary organization for start-up investment if they can, on the one hand, convince the best entrepreneurs to opt for their investment rather than the one of a traditional VC firm, and, on the other hand, provide their LPs with the highest returns. The academic literature and some interviews with some VC investors have helped me build some predictions.
1. What does the Entrepreneurial Finance Literature say?
Two conclusions from the entrepreneurial finance literature helped make a first assessment of their likelihood to perform well:
- VC firms and Syndicates differ on one aspect: the decision making process prior to the investment. While VCs generally review deals and make decision collectively within their partnership, a lead investor brings a deal to its syndicates’ backers, who, thereafter, decide whether or not they want to invest. As they are generally not professional investors, observers argue that backers are actually piggybacking on the lead’s investment decision more than making a decision themselves (see paper here). Therefore, one could expect that, because they can’t benefit from the collective reviews of expert partners, online syndicates are likely to meet lower returns. However, the interesting point here is that the literature argues the opposite. Research shows that the human capital linked to VC partners individually is 2x to 5x more important than the VC-firm’s organization capital (e.g., the benefits of having experts taking investment decisions collectively, or the attractiveness of the VC as a firm rather than as an assemblage of GPs) (see paper here).
Dustin Dungelow, GP at Maiden Lane (the organization investing Institutional money directly into syndicates that I mentioned above), provides some further explanations: “There is evidence that there is another approach that can at least perform as well, and in many cases outperform consensus-based investing, and that’s when an individual has an insane amount of conviction in some combination of product, team, and space and you have enough trust with them to let them pursue that conviction and take a bet. The next chapter of Venture Capital is, besides consensus, what else works? And, this is what I am working on with Maiden Lane: where does institutional capital belong?”. (If you wonder who has been taking investment decision alone and is super successful, check out this bio of Chris Sacca in the WSJ). - On the flip side, one very important online syndicate lack of is reputation and brand. The literature shows that more reputable VCs are not only those who have met the best performance, they are also those who add the most value subsequent to the investment (paper here). Therefore, entrepreneurs would be right to favor more reputable VCs over online syndicates. Brand also matters more and more in VC (check post 1 on the topic and NVCA’s study here). As of today, AngelList syndicates have no brands and can only rely on their lead investor’s past reputation as individual. In this case, they’re hence less likely to convince the best entrepreneurs to opt for their investments, and in the end less likely to perform — at least not before the end of a first cycle.
2. What do VC investors think of syndicates?
Interestingly, when we crawl the web looking for VCs’ opinion on AngelList syndicates, one can clearly distinguish two phases. A first one, right after syndicates were introduced (in late 2013), a second much more recent one (late ’15, beginning ’16).
Below, I refer to a few reactions from pro-eminent VC investors from the press and pursue with a few quotes I have gathered leading my own interviews.
1st phase: VC’s views after online Syndicates’ introduction in 2013
Fearing disruptions or “platformization” of their industry, many leading VCs have raised their voice just after online syndicates’ introduction.
Hunter Walk’s, Fred Wilson’s, Mark Suster’s and Jason Calacanis’ reactions were probably the most interesting. Jason Calacanis (n.b. his syndicate is now one of the most successful on AngelList) predicted for example that some leading syndicates on AngelList would quickly crowd out a whole bunch of second tier VCs— the ones that can’t “add value” beyond the money they invest:
“The bottom half of VCs will now be wholesale replaced by folks like Kevin Rose, Dave Morin and myself. The three of us have $1M in backers in the first week. That means if we collaborated on a project we can do an A-Round after a brief conference call”.
Relatedly, Hunter Walk raised concerns about the negative effect of turning successful Business Angels investing small tickets from their own pockets in larger investors investing money from other investors. These investors, now taking a larger chunk of deals’ total size, would mechanically crowd-out a whole bunch of smaller Business Angels that traditional VCs used to like letting in in their own deals in order to bring additional expertise to entrepreneurs.
It’s exactly this change of roles between the different key players in a deal that Fred Wilson and Mark Suster commented on. They both argued that previous Angel investors turned VC had neither the skills nor the experience to become lead investor in VC rounds. In VC, lead investors are the first investors to commit to a round, they take a large part of it, define the terms, and have an important signaling effect to other investors. Subsequent to the investment, lead investors take board seats, supervise companies’ operations and help raise follow-on rounds. As former successful angel investors, the leads of AngelList Syndicates mainly followed professional VCs’ decisions, and never played such roles. In this regard, both warned entrepreneurs against taking AngelList syndicates’ money rather than VC’s money.
2nd Phase: What VC investors think of AngelList syndicates in 2016
Three years after their creation, most reactions of VC investors in the US show that online syndicates are now an integral part of the early-stage financing landscape (nobody really cared in Europe).
“What is happening is that most of the top angel investors are turning into VCs, which is fine and we love working with VCs. We think that this is a very cooperative industry. So we also think that syndicates on AngelList could be a good partner for us”, commented a NYC-based VC.
Now, it seems that the VC ecosystem in the US has evolved quite a lot in the last three years, and traditional players invest huge efforts to differentiate from other VCs, but also from alternative sources of funding (including online Syndicates). “Our cash is greener because our cash is associated with more resources, that an individual Angel can’t realistically afford”, declared another NYC-based VC investor investing significantly in its Platform Strategy.
“It [AngelList syndicates] adds value and improves the ecosystem, but it won’t replace or disrupt us too much because we’re so hands on”, commented Jay Acunzo at NextView Ventures.
Nonetheless, it’s worth noticing that two leading VCs declared that they were now indifferent between having a second tier VC, not taking board seats or an online syndicate as a co- investor. In some cases, they even preferred an online syndicate because of:
- The speed at which they could complete rounds
- Their specialization (“We encourage our portfolio companies to work with the investor group that is most likely to be a good match for them prospectively. We had a drone company who looked for investors with domain expertise in drones on AngelList” reflected the NYC-based VC investor)
- The publicity it creates for portfolio companies to raise funds on AngelList considering the traffic gathered on the platform.
These comments suggest that, so far, online syndicates were interesting complements of leading VC firms, and sometimes substituted second tier VCs.
“If your strategy is to be hands-off, and tag along a lot of deals, you should pay careful attention to what’s happening on AngelList” commented another Boston-based VC.
However, this replacement of second tier VCs might not work on any deals.
“AngelList likes companies with traction, and big name VCs as investors. And B2C over B2B. You have to tick all the three boxes”, reflected Lou Kerner, who manages one of the 25 syndicates spearheaded by Gil Penchina.
The fact that backers require “big name VCs” as co-investor confirms that online syndicates are not likely to substitute VC firms, at least not until the end of a first Venture Capital cycle when online syndicates’ performance will be available.
3. Backing these qualitative results with actual data
Now, gathering feedback from VCs would not prove anything, so I scrapped data on all disclosed deals on AngelList (summing them up, disclosed deals corresponds to c. 80% of the total amount invested by syndicates) and crossed it with performance data of each online syndicates’ portfolio companies available on Crunchbase.
Here is what the data says:
- Measuring the ratio of the funds brought by the syndicate over the total size of the round, one can notice that online syndicates had a rather low contribution to the round they participated in. It suggests that online syndicates had more of a “follower” role than a “leader” role. This contribution even decreases over time.
2. Pushing the analysis, a bit further, and discriminating by online syndicates’ tiers*, one can see that this contribution evolves around 20%, but is significantly lower for syndicates from the Tier 4.
Interesting is also the dynamic, as contribution from first Tiers’ syndicates gradually decreases while lower Tiers’ increases. It seems to be stabilizing around 20%:
(* Tier 1 had more than $1M in backing in 2015, Tier 2 had between $500k and $1M, Tier 3 had between $250k and $500k, and Tier 4 had less than $250k.)
3. Finally — and I would not draw any conclusion too fast on this — but when one cross the total amount raised by portfolio companies over their lifetime (which is a first proxy for portfolio companies’ performances) with the contribution (in %) of the syndicate to the funding round in which the latter took part, one could argue that the lower the contribution the higher the total amount raised by the company:
Conclusion
At the end of the day, what both interviews and data seems to be saying is that:
- AngelList syndicates become an important source of funding, but they are more of a complement than a substitute to traditional VC firms.
- VC firms are likely to be more hands-on and bring larger expertise. They are also full time investors (compensated with management fees) who could be more present in bad as well as good situations than lead investors of online syndicates, who get compensated only on performance with deal-by-deal carry (see Fred Wilson’s post on bad incentives mechanisms due to deal-by-deal carry).
- AngelList syndicates bring faster decisions, a larger visibility online and a larger network of smaller co-investors who, overall, might be a little more passive.
The strategic path taken by Gil Penchina’s group of syndicates (Flight.vc) might even be an early illustration of a model that is fundamentally different from the one of a VC firm. Flight.vc rather fosters a new way of investing, and aims at participating as co-investor in the best deals rather than really leading their own deals.
Flight.vc hence leans towards a model that is closer to that of mutual fund than that of a VC fund and aims more at allowing backers to decide themselves of their investment focus.
«The analogy behind Flight.vc is to be the Fidelity Investments of crowdfunding. Started in 1946, Fidelity has an all star group of fund managers managing a diverse group of 576 mutual Funds for 24 million customers” reflected Gil Penchina in a recent Harry Stebbings’ 20-min VC podcast.
One could see this as the ultimate democratization of start-up investing.
So if I had to answer the question in one sentence, I’d say that AngelList syndicates and VC firms are rather friends than foes — at least if we consider only the best VC firms. They might be foes with some second tier VCs. In any case, their advent seems to be a good news for the funding ecosystem :) .
The most promising aspect might even be the synergies between VC firms and syndicates. These synergies have btw not been unnoticed by some leading VC firms, which have started to create their own online syndicates. These take advantage of some of online syndicates’ possibilities, and raise additional money from accredited investors that they invest alongside their traditional fund.
Special thanks to Christian Catalini at MIT, whose constant availability and expertise on equity crowdfunding was of precious help while writing this part. Thanks also to TJ Mahony and Jeff Fagnan, GP at Accomplice and AngelList’s board member, to Alex Mittal at Fundersclub and to Lou Kerner, lead investor of one the syndicate within Flight.vc, for accepting to share their views with me on the future of AngelList Syndicates.
