Angel List – VC Friend or Foe?

Much has been made of the emergence of crowd funding sites such as AngelList, Kickstarter and other competitors. According to many, they are dramatically changing the VC industry. When asked about the impact that crowd funding sites will have on the industry, VC’s have seemingly fallen into two buckets. The growing first group acknowledges the challenges that these companies are introducing and they thoughtfully discuss how they are trying to carve out their own market niche. The second, with a slight tremble in their voice, deny that crowd funding sites will really have all that much impact and that it is a passing fad. In this post, I am not going to argue that crowd funding sites will not impact the VC industry (because I believe that they have already begun to) but rather that the impact will not necessarily be negative.

Before arguing that sites such as AngelList may actually benefit VC’s, let’s start with some of the biggest challenges that they are creating. Most concerning is the reduction of barriers to entry for new investors to combine with other passive investors and create pseudo-VCs through deal syndication. With easy access to once proprietary deal flow, any interested investor with some time on their hands and access to (not that much) capital can set up a simple Mom and Pop 20% carry shop. When you consider that many of these syndicates do not (or are not able to) charge fees, there is a very real threat of price competition for traditional VC’s (why pay 2% fees when another syndicate doesn’t charge them?). When we consider the additional risks of ‘capital commoditization’, entrepreneurs raising at lower valuations due to more competition and a preference among some for ‘no strings attached’ capital, we understand why many in the industry are starting to sweat.

Despite these challenges, AngelList and other crowd funding sites provide several distinct advantages to VC’s that may enable them to thrive, albeit in a slightly different way.

·      Crowd funding has enabled Venture to appeal to the common investor
Distrust for Wall Street is at an all-time high and investors are tired of playing a rigged game. With two market crashes in the last 15 years that were “once in 10,000 year events” (see Nassim Nicolas Taleb’s Black Swan), everyday investors are tired of Wall Street getting rich while their investment portfolio continues to fall. There is an increasing group of high net worth investors in the baby boomer generation who enjoy the excitement of actively or semi-actively managing their portfolio, but recognize the cards are stacked against them in the stock market. AngelList has become an attractive option for some of these investors because it allows them to do some of their own research and pick specific investments that they can watch grow. The problem is…

·      …AngelList has revealed how hard it can be to manage deal flow
Yes, AngelList has lowered the barrier to entry by giving wide reaching access to deal flow. The problem for many angel or personal investors is that this can be overwhelming. With hundreds, if not thousands of companies currently listed on AngelList, how does an uninformed investor effectively screen through these companies and perform adequate diligence? One could take the Ron Conway planting many seeds approach, but the low barriers to entry have also led to a lot of bad companies making it onto AngelList. The low barriers to entry are both a blessing and a curse for unsophisticated investors – it will become increasingly difficult for individuals to sift through the countless opportunities (on AngelList at least) to find the meaningful ones.

·      Crowd funding platforms allow VC’s to syndicate more easily
While crowd funding platforms enable angels and common investors to syndicate their investments more easily, it is also making this easier (and more broadly available) for VC’s. Deal syndication between Angel groups and VC’s (or between VC firms) previously relied on strong relationships, experience working together or an introduction from a mutually respected party. Crowd funding platforms enable established and well respected VCs to syndicate on deals together without having to have any connection beyond on a common interest in the company.
 

·      Fund performance and reputation becomes more public, faster
Rather than waiting for the next NVCA publication to come out detailing the performance of the top and bottom quartile funds, crowd funding sites can provide real-time feedback on investing returns by tracking momentum. Investments are deemed to be ‘good’ if more investors pile into that company after you’ve put your money in, and bad if the reverse happens. Each investor is given a rating based on the success of their past investments, which is made public to other members. Crowd funding sites have the opportunity to serve as the ultimate venture meritocracy with funds flowing into new syndications based on past performance. Individuals make the ad hoc investment decision given the firm’s historical returns and rating. Over time, the truly ‘good’ investors will be able to make a name for themselves via superior performance. In turn, this will lead to…

·      …Anytime Fundraising
Rather than managing an exclusively closed-end fund that requires months or even years to fully subscribe, VC’s are able to mimic open-end characteristics through syndication. By syndicating single deals, pools of deals or a full portfolio, VC’s can open themselves to additional capital and earn carry on funds that otherwise would not have been available to them. By establishing a successful investment track record, VC’s can attract additional investment for future deal syndication. In the past, LP funds couldn’t be redistributed until after the life of the fund (10-12 years). In the crowd funding model, investor funds are shuffled and redistributed on a deal by deal basis and so reputation impacts fundraising even more than it would in the normal course of business.

With all of these changes, what does the future of VC look like? No one can be certain, but FunderClub seems to have a pretty good start on things. Open only to accredited investors, FundersClub filters through the wide array of possible investments in their deal flow to present only the highest quality options to their members (roughly one per month). Individual investors still make the ultimate yes/no decision on the investment, but FundersClub is committed to providing ultra-high quality deal flow to personal investors and often partners with other well-known VC firms on their deals. This type of model leverages the low barriers to entry that AngelList helped make popular with the investment selection rigor honed by VC’s over the past several decades. Only time will tell how the industry will continue to evolve, but in an industry that has thrived on the innovation of others for the last 30 years, it is amazing how nervous everyone is about a little change.