Angel and Venture Capital Are Broken – Part II
Angel Investing and Venture Capital are broken… or more accurately, not working the way they use to work.
We can blame the change on several factors:
- Lower Barrier to Entry for Startups – Technology Advances dramatically reduced the cost and resources required to stand-up a technology startup (see Part I) resulting in increased early-stage competition.
- Dot Bomb Meltdown and 2007 Market Crash – Fund performance underperformed many other asset classes souring Limited Partner Investors from startup investment.
- Dodd-Frank – The Volker Rule of Dodd-Frank enacted in 2008 barred government-insured financial institutions from over-weighting their portfolios in so-called, high-risk investments like Venture Capital funds. This reduced the pool of money available to invest in Venture Capital resulting in the shuttering of smaller less successful VCs and increased the difficulty to stand-up a new Venture Firm.
These and other factors resulted in fewer Venture Funds and concentrated power in the Mega VCs like New Enterprise Associates, Kleiner Perkins, Sequoia and the like. These firms all compete for limited partner investors which means they elbow out their competitors or other firms from deals. If you’re not one of the top funds, you aren’t going to have access to the real, true possible unicorns.
That’s one of the reasons you’re seeing fewer Venture Funds in DC. In 2000, there were at least 40 legitimate Venture Capital firms located in and making investments in DC. Now, if you don’t count 3Si, there are less than 10.
In this hostile environment, Venture Capitalists who are not part of the exclusive insider oligopoly must evolve or die.
Many like, Valhalla, Novak Biddle chose death. Others have evolved. Two models of note:
- PROOF VC – John Backus and Thanasis Delistathis of New Atlantic Ventures and John Burke, formerly of Tru Ventures got together with a new model. Their new PROOF fund works the edges of systemic issues inherent in the broken Angel, Accelerator, and Micro-VC model outlined in Part 1. They’ve built partnerships with 35+ Accelerators and Micr0-VCs. creating an interesting opportunity.
When early-stage investors place bets in high-risk companies, the more established Venture Capital funds watch and if one of those deals shows real promise, they swoop in like vultures and snatch the win from the early stage hunters. These established firms make huge bets that dilute the early stage money and then protect their bets with contract terms like preference and participation to make sure they get their pound of flesh before the early stage risk takers. As a result, there are no scraps left for early investors unless the startup realizes a true billion-dollar unicorn exit.
Instead of being elbowed out of the deal by the big boys, PROOF leverages its early-stage partnerships. These early-stage investors are usually barred to invest in later rounds either by a lack of capital or the structural requirements, leaving their pro-rata rights to expire unused (the right to continue to invest in later rounds so as to not be diluted). PROOF’s partnerships allow them to tap into these pro-rata rights that would otherwise go wasted giving them access to deals from which 2nd-tier VCs would normally be elbowed out. The result is they get to invest in late-stage attractive, vetted deals alongside top VCs. In return for the pro-rata rights, PROOF shares the carry with their early-stage partners. Win/Win!
- Private Access Network (PAN) – PAN, is the brainchild of Randy Domolky, experienced Venture Capitalist, and former Managing Director of VC firms Liquid Capital and GKM Newport and Scott Schedler, former President of the Motley Fool. PAN is an Angel Group, like Dominion Angels, Baltimore Angels, or the Dingman Angels. Unlike those Angel Groups, Randy’s and Scott’s relationships afford them access to better deals investing alongside VCs. Randy, for instance, was an investor in Tesla and SpaceEx. Because PAN doesn’t compete with Venture Capital firms for limited partner investors, VCs are more receptive to partnering with a PAN than a second-tier VCs who they view as competitors.
PAN is different than traditional angel groups. For one, Scott and Randy vet the deals first. They only bring deals to the group as potential investments if Randy and Scott have vetted, performed due-diligence, and unlike investors in Trustify Scott and Randy know how to do a search on google. Then and only then, if they both agree to invest their own money in a deal will they present a deal to the group. They only invest in later stages and they only invest alongside Venture Capital Firms.Unlike traditional VCs and more like traditional Angel Groups, members do not pledge a fixed amount of money from which the pro-rata share is drawn down for every deal. PAN members choose if and how much they invest in every deal.PAN’s early success is evidenced by the several local “hot deals” in which they participated: Upskill, StreetShares, and HomeCare.com.
Here’s a description of the options for people who want to invest in startups:
Venture Capital is like life… if you don’t keep moving if you don’t keep growing you die. While many funds are dying, PAN and PROOF keep moving and growing.
If you haven’t read part I of this series you can find it here: Angel Investing is Broken Part I