Going Direct: A New Paradigm in Venture Capital Investing

White Paper: Best practices for leveraging FinTECH to overcome inherent challenges with direct investing

The goal of this paper is to provide institutional investors, managers, and originators with a greater understanding of best practices for leveraging FinTECH to overcome inherent challenges with direct investing: liquidity, adverse selection, diversification, volatility, performance, scalability, access to best managers, and valuation.


Institutional adoption of FinTECH platforms in the P2P sector has been robust. Prosper’s (leading P2P originator) lending origination grew by 347% in 2014 (YOY) issuing $1 billion worth of loans in just 6 months surpassing the $2 billion mark for the first time in the fall of 2014. Highlighting this accomplishment, it took Prosper 8 years to reach its first $1 billion in originations. Ron Suber, President – Prosper, terms this explosive growth “Escape Velocity” or escaping the gravitational pull of traditional lending practices and constraints (~banking industry).

And what accounted for Prosper’s escape velocity? Institutional capital! Hedge funds have been the primary catalyst for Prosper crossing the $5 billion mark in loan originations (October 2015). On the equity side, institutional capital is gaining access to early-stage technology and scaling capital primarily via investor syndicates (~online venture funds) participating both as “lead” syndicators (~Arena Ventures) and members of syndicates managed by esteemed investors.

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Online Venture Capital … Why not?!

If there is one industry that has successfully resisted change, it is Venture Capital. There is no doubt Venture Capitalists (VCs) play a vital role in the capital markets assisting companies raise seed/growth capital to advance development programs. Major VCs devote significant amounts of capital from their Limited Partners (pension funds, endowments, foundations) investing in emerging growth companies following extensive due diligence by seasoned industry veterans, introduce valued networks assisting portfolio companies with operations, and facilitate successful exits (IPOs, M&A) given strong relationships with bankers and strategic buyers. For these services they are well compensated.

This sounds impressive. So what is the problem? Over the past 10 years VCs struggled to provide alpha (premium to established benchmark returns like the S&P 500) to reward investors for participation in a risky asset class. Though the recent IPO window and robust M&A activity will surely improve these metrics moving forward, many still feel the incumbent fee structures (“2” and “20”), long-term lock-up’s (~10 years), and reluctance to invest in early-stage opportunities and those companies located outside of San Francisco/Boston, is forcing companies to seek capital from alternative sources (accredited investors, family offices, limited partners direct).

Enter online venture capital

Fueled by advancements in social media (~Linkedin), passage of the JOBS Act (expanded shareholder cap and approval of general solicitation), and increased adoption of direct investing by alternative investors (i.e., Peer-to-Peer lending ~Prosper), the funding landscape is drastically changing! Whether in the consumer goods industry (CircleUp), technology (FundersClub and AngelList), healthcare (HealthiosXchange, Poliwogg) or real estate (Reality Mogul, SilverportalXchange) industries, investors are increasingly sourcing and investing in deal flow (private equity) directly. As with the discount brokerage revolution (rise of online public equity trading platforms including Schwab and TD Ameritrade), technology is altering the landscape of how investors participate in private equity.


One area where technology is reshaping the investment landscape is what many are calling “Convergence.” This term describes the merging of retail and institutional pools of capital resulting from the proliferation of online platforms including Peer-to-Peer Lending (P2P), and equity crowdfunding/direct investing (AngelList, Fundrise, Mosaic).

A recent article, “Has Peer-to-Peer Lending Turned Into Hedge Fund-to-Consumer Lending?” by JD Alois, Crowdfund Insider, highlights convergence:

  • “While P2P lending started out by matching an individual borrower with an individual investor things have rapidly changed. The outsized returns generated by the various P2P platforms have not been missed by institutions and hedge funds.”
  • “During the last quarter, almost 60% of the $1.1 billion in loans originated on California-based Lending Club – the largest P2P lender in the US – were snapped up by asset managers, banks, hedge funds, insurance companies, pension funds and other institutions. At Lending Club’s main competitor, Prosper Marketplace, 66% of loans went to these same types of investors.”

Though the merits of institutional capital’s involvement in the P2P industry can be questioned (hedge funds have acquired large portfolios of P2P loans and securitizing them to attain leverage), there is no denying the evidence supporting how technology is facilitating convergence between retail platforms and institutional investors.

Investor Syndicates

It is just a matter of time until blue-chip venture capitalists launch their own investor syndicates. Why make this bold statement? Because the value propositions associated with leading investor syndicates are too compelling for Fund managers and professionals start-up investors to ignore including:
•    Online presence to build a following
•    Turnkey fund management tools to run venture funds (i.e. HealthiosXchange’s Reserve system)
•    Access to a marketplace of tens of thousands of accredited investors
Convergence is on the move. Institutional capital is “crowding out” retail capital (Peer-to-Peer), strategic buyers are moving online to meet promising emerging growth companies, and venture capital firms are launching investor syndicates to tap into additional sources of capital. Catch the wave!

Read more, or download the entire article, here.

Image © CanStock / tashatuvango

Crowdfunding + Crowdsourcing = Going Viral

What if emerging growth companies could easily reach 20 million investors! Sounds impossible but wait a minute. Last time I checked my Linkedin account it suggested I am connected to 20,882,416 contacts via 1st connections, 2nd connections (aggregate 1st Degree networks) and group members on Linkedin. Given I am a “top” 1% member of Linkedin (connected to 2,700 members), this reach may be unrealistic for most. However, even emerging growth company executives with 500-700 Linkedin members may have access to upwards of 5-10 million contacts.

What does this really mean in the context of private equity investing? It means under the new 506 (c) general solicitation rules (ability to solicit people with no existing relationship) companies can virally spread their message (via social networks) to those who otherwise may not become aware of the opportunity to invest in the next private “Google.” Couple this awareness with the ability to invest at lower investment thresholds (more readily diversify within private equity allocation), and this is a cocktail for adoption by Accredited investors.

Online investing in private equity is truly going viral! With the advent of advancements in technology (social media), emergence of crowdfunding (donation, reward, peer-to-peer, equity), and unprecedented legislation (JOBS Act approved in 2013), there has never been a better time for leveraging direct investing platforms (crowdfunding portals) to reach investors!

Empowering Networks

Crowdfunding portals “empower” company and investor networks (“rolodexes”) via the same technologies utilized by leading social media companies Linkedin, Twitter, and Facebook. Crowdfunding engines leverage text analytic (XML) technologies to collect data (from member profiles/company profiles), tag data (investor preferences/deal terms), and present data (match crowdfunding members with company offerings) via advertising, notifications (email, workflows).

The first and most obvious network to empower is Friends and Family. Empowering personal networks (friends, family co-workers, former co-workers, and prospective/current investors) is essential when seeking capital at earlier stages (seed), given many capital providers (venture capital) have moved to later-stage opportunities. HealthiosXchange, an equity crowdfunding portal serving the healthcare industry from “Seed to Exit,” empowers member friends and family networks by:

•    Providing tools for tracking referrals (personal ref codes sent to networks requesting referrals to join portals/follow companies/invest in deals), event participation (webinars, road shows), and company page visitors/activity
•    Keeping networks informed of catalysts (achievement of key milestones); encourage them to become investors (“Follow” companies and receive updates in real-time)
•    Encouraging page “Followers” to conduct due diligence by interacting with management, members (friend, follow, message, share) and by reviewing online documents, scoring etc.
•    Encouraging page “Followers” to share portals joined and deal activity with networks via social media platforms (Linkedin, Twitter, Facebook)
•    Incentivize page “Followers” to persuade networks to “Follow” and “Invest” in private equity offerings (i.e. if a broker dealer, ability to receive commission; if not, eligible to receive carry)

Read the rest of the article here


Lead image © Can Stock Photo Inc. / cienpies

Direct Investing Via Investor Syndicates

The Next Wave of Financial Innovation

Marc Andreessen’s (~Andreessen Horowitz) famous article, “How software is eating the world,” published in 2011 (Wall Street Journal) is a perfect backdrop for what is transpiring in the financial markets.

“My own theory is that we are in the middle of a dramatic and broad technological and economic shift in which software companies are poised to take over large swathes of the economy.”

FinTech is eating the financial markets.” That statement may be an exaggeration compared to the level of disruption in other industries including music (EMI/Pandora), videogames (Nintendo/Zynga), books (Borders/Amazon), entertainment (Blockbuster/Netflix), photography (Kodak/Shutterfly), and recruiting (Korn Ferry/Linkedin), however, technology’s impact on the financial markets is accelerating.

“More and more major businesses and industries are being run on software and delivered as online services—from movies to agriculture to national defense. Many of the winners are Silicon Valley-style entrepreneurial technology companies that are invading and overturning established industry structures. Over the next 10 years, I expect many more industries to be disrupted by software, with new world-beating Silicon Valley companies doing the disruption in more cases than not.”

One of the most innovative and potentially “disrupting” platforms in FinTech (financial technology) is crowdfunding (raising smaller amounts of capital from a large group of people). Crowdfunding is estimated to reach $10 billion in revenues (2014) doubling from $5 billion in fiscal year 2013. This white paper discusses one of the industry’s rising stars, Equity Crowdfunding, which is estimated to reach $800 million in revenues (8% of total crowdfunding revenues) up from $200 million  in 2013 (4% of $5 billion in revenues). One of the primary drivers of this growth rate is a platform referred to by market sponsors as “Investor Syndicates” (AngelList, HealthiosXchange) or “Circles” (CircleUp)

Investor syndicates are online investment (“venture”) funds whereby Lead investors (usually an individual with an established track record of funding companies/company exits) raises capital from the “Crowd,” or “syndicate investors” in return for carry. The advantages for lead syndicate investors includes expanded access to capital leading to heightened investment protections. For syndicate investors, they gain access to premium deal flow, leadership/industry expertise, and syndicate management and oversight.

You might be asking yourself, “equity crowdfunding revenue growth rates are impressive and syndicates look innovative, but why should I care?!” If you are emerging growth companies it means securing capital from the “Crowd” and for investors, access to premium deal flow/attractive annualized returns.

The unfortunate fact is that accredited investors do not have adequate exposure to private equity. Only 8% of the wealthiest investors in the United States have private equity investments in their portfolios and of this, 40% is in venture capital with obtrusive fee structures. This should surprise everyone given alternative assets (private equity) can generate annualized returns of greater than 20%+ and constitute an important source of portfolio diversification (uncorrelated to other major asset classes including stocks, and bonds).

Let’s start exploring why the percentage of alternative asset “ownership” is so small and how equity crowdfunding will increase capital flowing into promising private emerging growth companies.

Companies in every industry need to assume that a software revolution is coming.”

Equity crowdfunding is an ideal platform for increasing capital flows into alternative assets including private equity. As with the disruptive effects of technology innovations in other industries, equity crowdfunding is positioned to lower costs, increase access to premium deal flow, and make it more efficient to invest in alternative investments.

Available financing vehicle performance (as measured by invested capital and growth rates) ranges from superlative (angel groups and friends and family), to stable, (venture capital – “life sciences investing has averaged $1.6 billion per quarter with a standard deviation of $400 million since January 2001” – Source, Bruce Booth), to suboptimal (self-directed IRA’s).

Private emerging growth healthcare companies raise capital from six primary sources: Angel Groups, Super Angels, Broker Dealers and Registered Investment Advisers, Institutional Capital, Self-Directed IRA’s and Opportunistic.

To read more or to download the white paper, click here.

Image © Can Stock Photo Inc. / 1507kot

Self Directed IRA’s, Meet Crowdfunding

Let’s get this obvious statement out of the way: Investing in the seed/early-stages of a company’s life cycle is very risky. Of the 600,000 companies incorporated annually 12-24 companies will launch an IPO while venture capitalists invest in only .25% of companies reviewed. Some liken it to gambling in Vegas. So why are so many investors attracted to this investment class in light of the risks? The answer is that early-stage investing is a “hits” business. When companies succeed, they oftentimes return many times the initial investment (>10x), overcompensating for the losses, and private equity generates 25% annualized returns if structured correctly (Source: Wiltbank Study – Willamette University).

Leading opinion leaders have provided valuable guidance regarding how to correctly structure private equity portfolios. One such individual, David Rose, a successful Angel Investor (New York Angels) and author of “Angel Investing The Gust Guide to Making Money and Having Fun Investing in Start-ups,” mentions five “keys to success” for investing in early-stage companies:
•    Investing consistently – have 20-25 companies in your portfolio
•    Reserving capital ($’s) for follow-on financings
•    Be Professional in both your due diligence and deal-term negotiation
•    Going to be in it for a decade – illiquid assets
•    Add value to your portfolio companies above and beyond simply money

Equity crowdfunding, which leverages the Internet/Social Media to raise smaller amounts of capital per investor from larger groups of investors, is perfectly equipped to assist self-directed IRA investors with achieving attractive returns in private equity. In context of investing via tax-advantaged accounts, including self-directed IRA’s (investors more likely to use retirement accounts for private equity investing given they cannot touch assets regardless of the timing of exits – fitting for long investment windows), let’s delve into how crowdfunding empowers the “keys to success.”

To read more or download the article, click here.

Image © Can Stock Photo Inc. / alexmillos

FinTech and The Rise of Alternative Investing

Financial Technology (FinTech) is revolutionizing the financial services industry, including the way investors participate in alternative investing. From Ally (online banking) to eTrade (online discount brokerage) to Prosper (peer-to-peer lending), to HealthiosXchange (equity crowdfunding), technology is redefining the way we bank, trade stocks, lend money, and invest in companies. Fueling the transition to online marketplaces are tech-savvy Millennials who find visiting banks and participating in offline investment groups an inefficient use of resources/time and more costly than online alternatives.

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Mining for Meaning – How text analytics and sentiment analysis will redefine the capital markets

“Highly catalytic news and events…….are increasingly benefiting from improvements in the quality of filtering, contextualizing, and sentiment scoring that text analytics are now bringing to the table.” – Paul Rowady, “Inner Voices”

By its very nature, Crowdfunding defines the potential of Big Data. Those participating in such platforms rely on building social networks to identify investment opportunities, conduct due diligence, and keep informed of investments over time. All of these activities generate massive of amounts of sentiment data or indications of positive, negative, or neutral feelings towards a particular topic. By tagging this data (i.e., Metadata) and applying scoring algorithms, Crowdfunding platforms generate a guidepost for investment decisions.

Within this wave of innovation resides an engine fueling capital market efficiencies similar to the proliferation/impact of decimalized trading in the public markets, and it’s called “Text Analytics.” This term, often used in concert with “Data Mining,” refers to leveraging technology to identify patterns in unstructured content (i.e., social media), measuring meaning behind data (contextualization/sentiment analysis), and making the data productive via tagging/matching (i.e., buyer investment preferences to deal flow).

Why is sentiment analysis important? It has the potential to assist investors with making better decisions, leading to higher investment returns and subsequently more capital reinvested in the space.

Personalization of data or “getting the right information to the right person in the right place at the right time and in the right format” will be the future of the capital markets and Crowdfunding will play a major role in that transformation.

Read more here.

How Does Equity Crowdfunding Resemble the Discount Brokerage Revolution?

Schwab’s disruption of the status quo and commitment to low fees resemble the equity crowdfunding revolution.

Before laws changed in 1975, brokers were a necessity for buying stocks. In 1975, Schwab was one of the first companies to launch discount stock trading. Their “you can do it yourself” corporate mission statement undercut traditional broker-dealer trading costs by 30% or more. Similar to the legislation that reshaped stocks trading in the 1970’s, the JOBS Act is also watershed legislation for investors seeking to invest in private equity at lower costs. Title’s II and V of the JOBS Act will increase the amounts of capital available to companies from non-traditional sources (~accredited investors) given the ability to generally solicit while remaining private up to 2,000 investors. Regardless of the outcome of Title III of the JOBS Act (Crowdfunding, non-accredited investors), the dam has been cracked, impacting the establishment who have leveraged financial regulations to amass huge fees from investors and companies for over the past 70 years.

Read more about the parallels of crowdfunding to the discount brokerage revolution here.

The “Democratization” of Capital

Signing of the JOBS Act (April, 2012) signaled a new era for the “democratization” of capital providing Accredited and Non-Accredited (pending final regulations/approval from SEC and FINRA) investors unprecedented access to private companies/start-ups through Crowdfunding – a method of raising capital in small amounts from a large group of people using the Internet and social media.

Crowd Finance Portals inspired by the JOBS Act, including HealthiosXchange – “Healthcare’s Investment Marketplace,” and FundersClub’s “Managed Venture Funds” (technology sector focus), were subsequently launched to meet investor demand for early-stage investments (invest in the next “Google”) while meeting the need for diversification across a number of start-ups via low investment thresholds (as low as a $2,500 per investor per company).

In a Q&A session with a major pharmaceutical publisher, Scott Jordan answered questions about the prospects for crowdfunding in the life sciences industry.

Why does Crowdfunding work? How does Crowdfunding work in niche markets?

Crowdfunding works by democratizing the flow of capital to promising start-ups. When the JOBS Act receives FINRA/SEC approval, non-Accredited investors will have the opportunity to invest in private companies leveraging Crowdfunding technologies to diversify holdings across multiple early-stage companies. Advancements in Crowdfunding technologies (i.e., eDocuments/Payments, online due diligence and financial reporting) will assist early-stage companies raise capital from Non/Accredited investors more efficiently than current strategies which are largely opportunistic at best. Promising Crowdfunding platforms such as FundersClub and HealthiosXchange are utilizing these Crowdfunding technologies to attract investors interested in funding early-stage privately owned companies but currently dissuaded by existing Angel Group models requiring cumbersome time commitments (meetings), obligations to pay annual dues, and high investment threshold minimums (inability to diversify within a risky asset class).

Niche Crowd Finance platform such as CircleUp (focused in the consumer goods industry) and HealthiosXchange (healthcare sector) are ideally positioned to capitalize upon their domain expertise (both companies originate deals and have institutional pedigrees) and “Rolodex’s” of industry “Ecosystem” members (Large Pharma/Biotech, Venture Capital) to successfully Crowdfund Accredited and Non-Accredited investor capital. As evidenced by the recent collaboration of CircleUp with Procter & Gamble, Fortune 100 companies are seeking to partner with Crowd Finance platforms that can identify promising companies attracting capital.

What is the legal status of Crowdfunding?

Raising capital from Accredited investors has been legal and vibrant for many years in the United States under existing Reg D/Rule 506 exemptions. In 2011, companies raised over $905 billion through Reg D offerings. Even though a majority of this capital was raised in “yield” and “asset-backed” securities including oil and gas and private non-traded REIT’s, it still illustrates the power of this financing vehicle.

HealthiosXchange, launched by a leading healthcare investment bank, Healthios, is leveraging the Reg D exemption to launch the company’s Ex.PR.E.S.S. securities platform designed to raise follow-on capital (“Side Cars”) for Angel and Venture Capital-backed companies with strategic validation (partnership with large pharma/biotech), and near term exit potentials (12-24 months). Improving the risk/return profile for retail investors via platforms like Ex.PR.E.S.S. are critical given private companies in the life sciences sector do not yield (interest) or have short investment horizons most favored by this investor class.

The JOBS Act will enable Crowdfunding from Non-Accredited investors (Title III of JOBS Act). The SEC/FINRA have set preliminary investment thresholds per investor per year subject to change, based on the investor’s net worth and annual income. These governing bodies have been slow to implement this JOBS Act language given sensitivities surrounding the potential for fraud. Title III of the JOBS Act is forecasted to be signed by the end of 2013/early 2014.

Title II (Reg D) and Title IV (Reg A+) of the JOBS Act seem to be gaining more support/traction with regulators given these regulations focus on Accredited Investors. Title II contains provisions for General Solicitation of securities (no pre-existing relationships required) and increases the shareholder cap from 500 to 2,000 investors before a company would be required to “go public,” both integral to the proliferation of Crowdfunding Accredited capital under Reg D. Title IV expands the capital ceiling for Reg A offerings from $5 to $50MM.

Is there a risk only the more sexy diseases will get funded?

Yes, that is a concern but is consistent with the democratization of capital meaning capital flows will be based upon supply/demand. However, given Crowdfunding capital is sourced from various donors/entrepreneurs with myriad goals and aspirations, Crowdfunding capital should flow into a large number of disease states. Investors are projected to invest in sectors of healthcare with lower capital requirements/regulatory risks (i.e. Healthcare information Technology) and sectors generating EBITDA (i.e., Healthcare Services).

Read more

Scott answers additional questions in a complimentary 5-page handout, The “Democratization” of Capital Q&A:

  • What is the difference between equity Crowdfunding and non-equity Crowdfunding?
  • What’s the future of Crowdfunding? Is it just a fad?
  • What’s the current environment for funding for biotech/life sciences companies?
  • How important is this early stage funding for companies?
  • Is Crowdfunding a feasible alternative to other types of funding streams for life sciences and biotech?
  • What can Crowdfunding offer that donating to research charities can’t?
  • The product pipeline is dwindling at many pharma/biotech companies. Is Crowdfunding a solution to plugging the “innovation gap?”
  • What happens later on when the company needs additional financing?


Read The “Democratization” of Capital Q&A handout here.