What Do You Know About The “Online” Private Market?
Yes! there is a new private capital market that is growing fast, and it’s all happing online. In this new “online” private market, startups of all stages can raise unlimited amounts of capital from the public, on online equity funding platforms, without ever talking to a VC! In this post, I will shed light on this new market, and raise questions on the future of Venture Capital.
For many years, startups raised money from their friends and family, angel investors, accelerators, or pre-seed funds. Once they have built an MVP or a beta version, they move up the ladder to seed, early, then growth stage venture funds.
Communications between founders and startup investors had to be private by law, meaning, founders can’t advertise the funding rounds publicly, and can’t accept money from the public.
Unlike the public market, VCs had an edge in the private market when it comes to deal access, but not anymore!
AngelList syndicates were launched in 2013 in an attempt to commoditize startup capital, and help high net worth individuals get access to top deals early on that have been monopolized by VC firms.
VCs underestimated syndicates at the beginning. Now there are more than 200 active syndicates with thousands of LPs who have poured more than $1.5B in those syndicates. Since launch, 5,505 startups have received investments from those syndicates.
Yes, startups who make it past the seed stage eventually raise from VCs but think about all those LPs, their capital, the management fees, and the lost returns on all those early deals from the perspective of VC fund managers.
As a result, smaller firms that added no value took a big hit. Fewer founders reached out to them. Syndicates offer the same capital with more value by the syndicate leads who are eager to help as much as possible to win those deals.
Today VC is being disrupted again but quietly this time! Thousands of startups are raising millions of dollars, on tens of equity-crowdfunding or crowd-investing platforms, without ever talking to VCs!
Scott Kupor of A16Z mentions crowdfunding in his book “Secrets of Sand Hill Road” as one of two alternatives to VC. He even goes beyond that to say it might end VC as we know it.
When crowdfunding started, it was all reward-based, which was no threat to VCs. But then equity crowdfunding was legalized in three main forms: Reg CF, Reg A+, Reg D 506(c). This meant startups were able to advertise their funding rounds and raise from the public.
Tens of online platforms were created to match startups with public investors such as WeFunder, Republic, SeedInvest, StartEngine, NetCapital, and many others. Now anyone can find startups to invest in, with minimum accepted amounts as low as $100!
Since I started with KingsCrowd in January this year, I saw a jump in the total amount invested by the public in successful equity seed-stage raises from ~ $10m a month to more than $20m a month in the last 3 months. The number of new companies raising equity rounds online grew from ~10 companies a week in Jan, to ~40 companies a week now.
The online private market is more transparent and more liquid. Startups have to share their plans and financials just like public companies! Moreover, StartEngine and NetCapital have already launched their secondary markets and more are launching soon. Public startup investors don’t have to wait for an exit event (acquisition/IPO) like VCs do in the traditional market. People can invest now and then sell their shares at the next round if they want to.
When VCs invest in a startup, they dictate the investment terms to make sure they have special rights. But in this new market, founders dictate the terms, and whoever wants to invest can’t even negotiate those terms.
This market is expected to grow even more next year, especially after the newly approved changes that will enable seed-stage startups to raise up to $5m a year instead of only $1m.
How Is This Changing The Future Of VC
Many wonder if VC will be needed in the future! If more and more startups go the crowdfunding route, LPs and other investors can easily access deals, select the companies they like, and exit on the platforms' secondary markets.
But in my opinion, this is minimizing the role of a VC fund manager to only selecting. This is an oversimplification of VC.
I have worked with three VC firms, and we used to spend weeks/months researching industries, examining every single company in specific industries, to eventually uncover trends, and then develop hypotheses. Whenever we developed a market hypothesis, we started looking for companies that fill the gaps we were able to identify. Even then, we used to spend more time with the founders and all team members in a due diligence process to make sure it’s the right fit and that everything is in place. Many VCs proactively look for and connect with companies that fill specific gaps, as opposed to reactively evaluate whatever companies approach them.
Unlike crowd investors, top tier VCs work hand-in-hand with the founders to improve the success chances of their portfolio companies. They help in recruiting, business development, sales, marketing, operations, connections to other investors/customers, and even help in founders’ mental health in some cases. VC firms are more like agents. I wonder how this dynamic relationship will evolve in the future, and how crowd investors can replace it.
Crowdfunded companies are somehow similar to public companies in terms of having thousands of shareholders, this adds more pressure on founders by the “public” to produce financial results fast, which I worry will affect the startups’ health. I remember when I (at a VC firm I worked for) tied future financing rounds to performance goals, it was disastrous. Founders stopped thinking about innovation and pivots and focused on short term goals. A startup is an entity looking for a scalable and repeatable business model, it’s going from zero-to-one. Whenever it reaches that model, not before, it can focus on execution and financial performance.
I’m a believer in crowdfunding. My Kauffman Fellows graduate project was focused on crowdfunding. But I’m also a believer in the value that VCs add. So I wonder how VC will look like in a few years if more companies opt in the crowdfunding track.
Will we see funds sourced from the crowd or even traditional LPs to: select top startups, add value, and manage a portfolio professionally? What does portfolio management mean now in this online market that is more transparent and more liquid? Will VC funds add value by helping startups raise more from the public in future rounds? Will they help in PR and in accessing bigger groups of retail investors? Or will VC funds become more like Hedge funds but focus on medium-term “trading” strategies?
When it comes to VC fund managers, in the early days of VC they used to be financiers, then we started seeing more non-finance managers excel in VC with higher returns and more relatable experience in building startups. Those excellent fund managers came from different backgrounds such as founders, product managers, engineers, and many others. But in this new market, are we going to see a comeback for finance managers who will manage VC funds like semi-liquid hedge funds? Will we see more emphasis on data-driven investing now? If yes, what kind of data? Would it be easier now to do quantitative investing in those semi-liquid startups?
I believe all these questions and more should be discussed by the VC community to make sure the venture industry adapts to the ever-changing world of startups.
At KingsCrowd, we aggregate, research, analyze, and rate companies raising capital on all online private markets, from pre-seed to pre-IPO. Then we provide our analytics, ratings, and research to crowd and institutional investors for them to make informed investment decisions.
