Why the path to democratising investment is inevitable
Originally printed here in Cityam, authored by Simon Cook, CEO of Draper Esprit
“Maybe you’re just not ready for venture capital”, said William H Draper to a potential Limited Partnership. It was 1957 and Draper was trying to persuade the firm to invest in his new fund, different to any other investment opportunity on the market. “Oh, no, no, no,” the LP replied. All of a sudden, the cards turned, and he signed it.
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General William H. Draper, the grandfather of our founder Tim Draper, was the former Undersecretary of the US Army and the man responsible for economic reconstruction of Germany and Japan under the Marshall Plan. He was also responsible for establishing the first Venture Capital firm in Palo Alto, bringing money to the “brash young technologists who were using bits of silicon to create an information revolution as profound as the industrial revolution a century earlier.”
There had been other examples of Venture Capital before this. In France there was the entrepreneurial bank Credit Mobilier, established in 1852. While in 1946 in Boston, JH Whitney & Co opened their doors with $10 million to invest in new business models. But the novelty with Draper’s new fund, Draper, Gaither & Anderson, was how it used a fundamentally different model of investment; this was the first private VC limited partnership.
The model is important because it has been left largely unchanged. The 5 + 5 year LP model [LS1] clearly works for many successful VC funds and has funded some of the biggest success stories that have sprung from Silicon Valley, and indeed the rest of the world. What began as a leap of faith for the first investors into that fund in 1964, is now commonplace; a model used by thousands of venture firms across the globe.
However, one key problem with this model is that the benefits of high growth companies such as Google or Skype are reaped primarily by private investors with access to large portions of capital. Whereas in the 20th century, the companies that brought in the most money also employed the most people, the high growth tech businesses of today are reversing this trend. In 1962, General Motors, one of the top five companies by market capitalisation, employed more than half a million workers. Today, four of the top five companies (Apple, Google, Exxon and Microsoft) have a combined total of 300,000 employees. The financial benefit of these companies, then, lies primarily with their investors. We need a new way of distributing the wealth that private investors enjoy.
Crowdfunding, on platforms like Crowdcube, doesn’t just enable entrepreneurs to raise money from potential customers and empower them to create new businesses. When managed correctly, it also gives members of the public a chance to reap the rewards of high growth businesses. Private investors play a critical role, but they need not be the only investors at the table.
The Crowd and VCs as partners, not competitors
But it’s also no secret that individual startups are a higher risk investment, requiring a portfolio approach. Whereas the crowd is reliant on the platform to mitigate initial risk in advance of a proposition being pitched, VCs mitigate risk through managing their portfolio closely. Good VCs will be magnets for excellent networks of advisors, talent and management experience; they answer the phone at 2am on a Saturday night during the inevitable tough times. If you’re a member of the public wanting to invest in a new company, you may not have the expertise or the global networks that venture funds offer their entrepreneurs. That being said, many investors on crowdfunding platforms do have a vested interest and frequently become valued mentors or advisory board members. Crowdfunding turns excited investors into powerful advocates, potential customers, and happy beta testers. Combined, VCs and the crowd offer entrepreneurs are potent platform to begin their business.
This is why VC firms such as Draper Esprit are changing in several critical ways. The first is that we regularly invest alongside the crowd. This enables those of you investing using platforms, like Seedrs or Crowdcube, to invest in a company which is also being helped with the networks, management advice and guidance of a seasoned VC. This is surely a win-win for everyone. In fact in our latest investment into the promising company, Perkbox, we invested on the same terms as those who invested on the Seedrs platform.
The second is that we ourselves decided to innovate the venture capital model and publicly list ourselves vis our IPO. Sounds like an oxymoron, I know. But we did this to open up the VC model further to public investors: anyone can now invest in our portfolio of fast growing companies (from PushDoctor to Graze). It also enables us to provide patient capital to entrepreneurs. The typical model of the 5 + 5 year LP fund places pressure on European startups to show returns quickly. We know that the best global businesses take much longer to build to their maximum potential. We’ve gone public so our portfolio companies don’t have to until they’re ready.
We are strong believers that VCs, angels and the crowd can work together to provide the right long term patient capital for the best entrepreneurs.
We are in the early, pioneering stage of crowdfunding and in public, patient capital models like our own. There is risk involved in investing in a new way. But as technology is opening up the way we communicate, the way we connect, the way we learn, so too will it demand we open up the way we invest. We are strong believers that VCs, angels and the crowd can work together to provide the right long term patient capital for the best entrepreneurs. Together we can empower teams to build global companies that last, and for that benefit to be enjoyed more widely.
